NEW YORK (
) -- As human beings we hedge all the time. Even though I live in one of the sunniest cities in the world, I usually have a jacket ready, just in case.
In the market, a hedge can be constructed from many types of financial instruments including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of over-the-counter and derivative products and futures contracts.
This has been yet another bad year for the hedge fund industry. One of my clients sent me an article that listed the average hedge fund return of 6.2% for the year to date in 2013.
How could this be a bad year for hedge funds when the market has had one of its best years ever? It makes me wonder how the hedge funds will fare during a bad year in the market. With the market up over 26% in 2013, how can the average hedge fund be up only 6.2%?
Here is the answer to that question: The cost of hedging has been very high this year.
A $200 vacation can become $300 real quick if you do too much hedging. You can insure your luggage, trip cancellation, rental car, etc. A whole life insurance policy does not come cheap. Neither does a big position in an underperforming asset.
I have pointed out many times in the past year the wide range of returns from the various asset classes. From small-cap U.S. stocks, which are up over 38% year-to-date, to gold, which is down 26%, and everything in between.
With just one month left to go in 2013, a 50/50 bond/stock portfolio year-to-date is up 6.5%, just about in line with the average hedge fund! In 2012, the market was up 11.8% but a 50/50 fund was only up 5.9%. But in 2008 a 50/50 fund bought you a big chunk of protection. With the stock market down 38.5% and the bond market up 32.1%, the net was just a 3.2% overall loss.