Index fund vs hedge fund manager

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argonautI
Posts: 9
Joined: Sat Sep 26, 2020 10:21 am

Index fund vs hedge fund manager

Post by argonautI »

I have read so many times that just investing passively in index fund such as SP500 will do better than 80% of active hedge fund manager over time (>=10 years). Warren Buffett also had said this several times and even had a won a bet against a hedge fund manager on this. And I believe this is probably true. However, it seems to be that this applies mainly year to year % performance. It is indeed hard to beat an index fund such as SP500 year after year consistently based on percentage return.

However, I am wondering if this still applies to absolute returns which in the end, I would argue is probably the more important metric. In another words, forget about the year to year % returns. Is this true based on absolute returns at end of long period of time like 10 years? Is there any data to support or refute this. It seems to me that if a hedge fund manager or an individual can buy a one or few stocks that hits a home run (like getting Tesla, Amazon or Apple like 10 years ago or even just a 1-3 years ago...someone like Cathie Wood) then it does not matter if they beat SP500 index year by year over time. At the end the day, they went up so much on these stocks may be in just 1-3 years (maybe return of >100%) that they can be market underperform rest of the years. It seems to me that SP500 index can't match the absolute returns even after 10 years in these situations. I'm curious to see how often this happens or if anybody have looked into this.
mhalley
Posts: 10432
Joined: Tue Nov 20, 2007 5:02 am

Re: Index fund vs hedge fund manager

Post by mhalley »

I can’t vouch for the research but Reddit says
I analyzed the performance of 5000+ Hedge Funds over the past 24 years and benchmarked it against SP500. Here are the results!

The individual performance data of hedge funds are extremely hard to get [3]. For this analysis, I would be using the Barclay Hedge Fund Index that calculates the average return [4] of 5,878 Hedge Funds. The data is available from 1997.

S&P500 has beaten the hedge funds summarily with it returning a whopping 222% more than the hedge fund over the last 24 years [5]. This difference becomes even more drastic if you consider the last 10 years. During 2011-2020, SPY has returned 265% vs the average hedge fund returns of just 60%.
https://www.reddit.com/r/wallstreetbets ... lyzed_the/
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happenstance
Posts: 306
Joined: Sun Jul 26, 2015 11:24 am
Location: NYC

Re: Index fund vs hedge fund manager

Post by happenstance »

I think you have it backwards. In any given year, some percent of managers will outperform the index. To do do even 3-5 years in a row is not unexpected. But to do so over the long term (20-30 years), especially after fees, is unlikely. Hot performance brings hot money, which dilutes the capacity of the strategy. And hedge funds typically allocate tactically, meaning they don't have a fixed strategy, providing more opportunity to make a bad bet. Some rare managers may even have the skill or luck to have consistent, long-term outperformance. But how do you know which manager is the winner beforehand? You don't, so you buy the index.
Makefile
Posts: 2657
Joined: Fri Apr 22, 2016 11:03 pm

Re: Index fund vs hedge fund manager

Post by Makefile »

When people talk about the index returning X% annualized over a 10 period, the full 10-year performance (what you call absolute performance) is already factored in. You take the value of the total return index (i.e., dividends reinvested) at the end of the period, divide it by the value of the index at the beginning of the period, and take the tenth root of that.

So if the index returns 7% annualized for ten years, $1 becomes $1.96. It doesn't matter whether that's exactly 7% for ten years in a row, or -50% the first year and and 16.39% per year for the subsequent nine years.

Sometimes averaging percentages like that can be taken the wrong way. For example, suppose you buy a stock. It drops 50% the first year, then gains 50% the second year. At the end of the second year, do you have less than, the same as, or more than you started? The "intuitive" answer is the same since -50% and +50% seem to cancel out, but of course it's less because 0.5*1.5=0.75 for a 25% loss over two years (or -13.4% annualized)
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