An earlier version incorrectly indicated that David Einhorn of Greenlight Capital had decided to quite the hedge-fund business.
Do you harbor the sneaking suspicion that someone, somewhere, is making a killing in the markets while your portfolio languishes? You’re not alone. Fear of missing out is a powerful emotion, especially in the wake of a year like 2018 in which the average actively managed open-end mutual fund (according to Morningstar Direct) lost 7.9% — almost twice the loss of the major U.S. market averages.
Common though fear of missing out, or FOMO, may be, you should do all you can to resist it. Far from motivating you toward better behavior, it actually is quite pernicious — tempting you to make an endless series of mostly losing bets.
A good analogy is a slot machine. Every few minutes one of the many machines in a casino will hit a jackpot, leading to sirens and bells and general hoopla. This induces in everyone else the sense that “I could just have easily been the winner” and, in turn, “let me keep trying again and again.”
Take hedge funds, which in many individual investors’ minds is where many of the investment arena’s jackpots often occur. One jackpot winner in 2018 was Northlander Commodity, with a 2018 return of 52.7%. Crescat Global Macro did almost as well with a 40.5% gain.
Gains more than enough to activate our fear of missing out, to be sure. But, just we focus an inordinate amount of attention on the winners, investors tend to overlook other hedge funds that did poorly. David Einhorn’s Greenlight Capital, for example, had one of its worst years ever in 2018, losing 34%.
The key, of course, is to focus on the average. According to the Credit Suisse Hedge Fund Index, a composite of approximately 9,000 hedge funds that reflects performance net of all fees and expenses, the average hedge fund in 2018 did barely better than the S&P 500 SPX, -0.39% , losing 3.2%. While that’s better than the average open-end actively managed mutual fund, it’s hardly the stuff to trigger FOMO.
To be sure, this composite index reflects many different types of hedge funds, only some of which focus on the stock market. Perhaps the most relevant categories for showcasing hedge funds’ stock market hedging abilities are “Equity Market Neutral” and “Long/Short Equity.” According to the Credit Suisse indexes reflecting those particular categories, such funds did even worse in 2018, on average, than the overall composite — losing 5.0% and 4.6%, respectively.
To be sure, hedge funds are generally less risky than a 100% stock portfolio, so a fairer comparison is with a benchmark that is not fully invested in equities. The one I chose for purposes of illustration in this column is a hypothetical portfolio that is 60% invested in the S&P 500 and 40% in intermediate-term U.S. Treasury bonds. This 60/40 portfolio has experienced almost identical volatility of returns over the last 25 years as the Credit Suisse Hedge Fund Index.
This 60/40 portfolio lost 2.1% in 2018, versus the 3.2% loss for the average hedge fund. Last year’s performance was not a fluke: Over the past 25 years, the 60/40 portfolio has beaten the Credit Suisse Hedge Fund Index by an annualized margin of 7.8% to 7.3%. A 60/40 portfolio that substituted long-term Treasurys for intermediate-term Treasurys would have done even better, producing an 8.9% annualized return. (See accompanying chart.)
Needless to say, this discussion is not an exhaustive analysis of hedge fund performance, and by no means is it the last word on the matter. The hedge fund world contains many extremely smart and shrewd money managers, some of whom undoubtedly will do very well by their clients. But the same could be said about actively managed mutual funds. Or, indeed, the investment newsletter industry, which I have devoted my career to tracking.
This is important to emphasize since many consider newsletter editors to be little better than self-promoters. Since mid-1980, when I began monitoring the industry, the best-performing investment newsletter has outperformed the best-performing mutual fund.
I’m referring to The Prudent Speculator, edited by John Buckingham. I calculate that it has produced an annualized return through Jan. 31, 2019, of 14.6% annualized. In contrast, Fidelity Contrafund FCNTX, +0.82% , the best performing open-end mutual fund over this period, has produced a total return of 13.6% annualized.
The challenge, as always, is finding the needle in the haystack. Focusing on that challenge is a far more useful expenditure of energy — far more useful than succumbing to the fear of missing out.
For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email mark@hulbertratings.com .
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