Investment News ran this piece, summarizing a book by Simon Lack, a former hedge fund executive at J.P. Morgan. Other publications ran similar articles, often with a more scandalized tone.
Mr. Lack's headline grabbing finding is that the capital that went into hedge funds would have reaped higher returns if had been invested in Treasury bonds. He identifies the primary culprit as the "2 and 20" cost structure of the typical hedge fund, aided by difficult capital markets over the last ten years and a highly competitive environment.
I haven't read the book yet, but I would guess that another factor is the amount of dishonesty the industry attracted in the first decade of the 21st century. Investors that had become accustomed to 20%+ returns of the 1990s realized that they really did not have a high tolerance for risk. These investors came to believe that a lower risk portfolio should be able to return 12% annually, and a number of shady characters were willing to promise it to them. 100% loss of that capital would have a profound effect on the return on the total capital invested in hedge funds.
At the end of he day, a hedge fund is just an investment vehicle, and an expensive one at that. Anyone investing in a hedge fund should expect such an high expense ratio be accompanied by a strategy that can not be duplicated in a lower cost form, such as a mutual fund , ETF, REIT, or Unit Investment Trust. Sophistication could be indicated by high velocity trading, illiquid or privately negotiated investment or derivative contracts, or leverage. What all of these strategies involve is additional risk. Not necessarily the risk that we recognize and talk about every day, but incremental risk nonetheless. And that should come as no surprise, since no investment provides a return unless the investor is willing to assume some level of risk.
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