Are Hedged Mutual Funds Good For Investors?

Hedge funds offer investors a lot of alternatives to profit or hedge in financial markets. Unfortunately only accredited investors can invest in them. If your net worth isn’t north of $1 million or your income is less than $200K you can’t have the privilege of giving hedge fund managers 2% of your assets and 20% of gross returns. Hedged mutual funds are trying to offer the same strategies for lower fees and they only require an average minimum investment of $5000. They are also regulated by the SEC, providing investors more protection. This seems too good to be true. Can hedge mutual funds really deliver hedge fund like returns? Are hedged mutual funds good for investors?

In 2009 Vikas Agarwal, Nicole M. Boyson, and Narayan Y. Naik published an academic paper in Journal of Financial and Quantitative Analysis answering this question. The title of the paper is “Hedge Funds for Retail Investors? An Examination of Hedged Mutual Funds”. Here is what they found:

Recently, there has been rapid growth in the assets managed by “hedged mutual funds”— mutual funds mimicking hedge fund strategies.We examine the performance of these funds relative to hedge funds and traditional mutual funds. Despite using similar trading strategies, hedged mutual funds underperform hedge funds. We attribute this finding to hedge funds’ lighter regulation and better incentives. Conversely, hedged mutual funds outperform traditional mutual funds. Notably, this superior performance is driven by managers with experience implementing hedge fund strategies. Our findings have implications for investors seeking hedge-fund-like payoffs at a lower cost and within the comfort of a regulated environment.

The paper states that “controlling for differences in risks, fund characteristics, and past performance, HMFs underperform HFs by approximately 3.3% per year on a net-of-fee basis”. The paper also found that “despite higher fees and turnover, HMFs outperform TMFs by as much as 4.8% per year on a net-of-fee basis when controlling for differences in risks, fund characteristics, and past performance”. There you have it. Hedge funds are still better investments than hedged mutual funds, and hedged mutual funds are better investments than mutual funds. However, this is true on the average and these statements were valid for the period prior to 2009. Hedge fund performance has been declining and new types of hedged mutual funds came to existence recently.

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