Ben Chu: The dumb money is still flowing into hedge funds – and it belongs to you

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The Independent Online

Outlook More money than God. That's one of the colourful descriptions of hedge fund managers and the title of a fine history of the industry by Sebastian Mallaby.

Leaving aside the Almighty's personal finances, it's certainly true that hedge funds have more money from investors than ever before. Figures from Hedge Fund Research last month showed $15.2bn of net new capital flowed in during the first quarter of this year. Total funds under management have hit $2.375trn, up fourfold since the turn of the millennium.

The enduring popularity of hedge funds is odd. The HFRX index, a rough measure of the industry's performance, rose by 3 per cent last year. Meanwhile, the S&P 500 share index put on 18 per cent and the FTSE 100 returned 6 per cent last year. A passive stock market/bond market tracker would easily have beat the aggregate of the actively managed hedge fund sector over the past decade.

The 2008 crisis gave the lie to the ubiquitous boasts from hedge fund managers that they had the skill to deliver "absolute returns", in other words delivering profit in good times and bad. In the market turmoil of that year, hedge funds lost more money than they had ever made. Hundreds of funds went bust. And many investors discovered they couldn't pull their money out in a hurry.

Despite this searing experience for investors, the money keeps rolling in. It's not as if the hedge fund fee structure has become any more attractive since the financial crisis. The gouging of customers goes on. Many funds still charge the old "2 and 20" of an annual management fee of 2 per cent of capital under management and 20 per cent of the profits on top. "A pretty dumb way to manage your money" was how Sir Mervyn King described paying such extortionate fees in Parliament a few months ago. Given those pathetic returns, he's plainly right. The profits of the punters have been lower than the fees of the managers for a very long time. The customers' yachts have yet to be located.

So what's going on? Why is a manifestly failing sector still sucking in customers? The most likely answer is that the dumb money hasn't worked out that the industry, as a whole, is a con. They are still getting the wool pulled over their eyes by those flattering prospectuses which highlight a fund's time-weighted (rather than money-weighted) returns.

Some investors are still suffering from the delusion they have the ability to pick the small number of managers who will have the skill (or more likely luck) to deliver positive returns after the humungous fees.

And, most depressingly, it's lumbering institutional investors, accounting for more than 60 per cent of assets, that are some of the biggest mugs in this market. That means your pension fund and mine.

One of the biggest fixtures of London's hedge fund party scene – Arpad Busson's ARK charity ball – will not be held this year. "It was all getting to feel a little bit 1788" one person connected with the event told the Financial Times, evoking the spectre of the French Revolution. How sensitive.

But make no mistake: while the dumb money continues to pour in, the hedge fund managers will still be partying in their hearts.