IRA Investing: Hedge Funds Are My Friends

Fads in stock market investing are nothing new. Every so often, an investment strategy comes along that is almost universally accepted and praised. The "Nifty Fifty" era of the 1970s comes to mind. These explosions in popularity don't usually benefit most investors. But sometimes monitoring the fad and analyzing the actions of the participating investors can give us important clues about the investment environment.

Over the last few years, one of the biggest stories related to investing has to be the tremendous growth of the hedge fund industry and its impact on the stock market. According to the Barclay Group, assets under hedge fund management have increased fivefold over the last five years, ending at $1.5 trillion in 2006.

The strongest growth occurred in 2003 and 2004, with assets increasing more than 60% in each of those years. What is the reason for this amazing growth? Clearly, growth was spurred by the disastrous market of 2001-02, when many aggressive investors saw their stock market investments decline by 50% or more.

Many investors seemed to have short memories and were looking for ways to protect themselves (or even profit) from the next bear-market move. Since hedge funds can take major short positions, it seemed obvious to many that the superstar fund managers would earn their hefty fees by making money in both up and down markets.

How has it worked out? Not well, I'm afraid. Hedge Fund Research publishes performance results for all the different types of hedge funds, and not a single index group has performed better than the S&P 500 in the last four years.

For example, the Equity Hedge Index, which is composed of hedge funds that attempt to time the market by holding both long and short positions, has increased 33% in the four years ended Dec. 31, 2006, but the S&P 500 is up 73% during the same time period.

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At the time of publication, Moore was long the S&P 500 SPDR, although positions may change at any time.

Richard Moore, CFA, has 40 years of experience in various facets of the investment business. He has been employed by banks, mutual funds and investment advisory organizations during his career and has also owned retail and service businesses. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Moore appreciates your feedback; click here to send him an email.