Canadians with money invested in domestic hedge funds would have been better off in the first quarter buying a passive fund that tracks the S&P/TSX composite index.
From January to March, Canadian hedge funds earned an average of 3.96 per cent, according to Bank of Nova Scotia's Canadian Hedge Fund Index. The TSX benchmark, meanwhile, earned 5.24 per cent.
This isn't the first time the hedge funds have underperformed a passive, and less costly, index-investing strategy. In fact, 2013 was an abysmal year for them.
Last year Canadian hedge funds returned an average of 4.39 per cent, while the S&P/TSX gained 9.55 per cent. That's more than five full points of underperformance. And the hedge funds' returns only look worse when comparing them to the S&P 500, which jumped 29.6 per cent last year, before currency adjustments.
The silver lining this year is that the funds are beating the S&P 500, which gained only 1.3 per cent from January to March (again, that's before currency adjustments; if you factor in the loonie's depreciation, the S&P 500 outperforms.) Hedge funds also continue to beat the DEX Universe Bond Index.
Still, the poor performance relative to the TSX raises more questions about their long-term returns. Since Scotiabank created its index in 2004, hedge funds only beat the S&P/TSX composite and the S&P 500 when their returns are asset-weighted. When they are evenly-weighted, meaning they are calculated as a simple average, the returns are simply on par with the indexes.
The issue is a hot one in the U.S., prompting many people to wonder why there is such an allure to hedge funds. Barry Ritholtz keeps musing about the topic, and he outlines his theories as to why investors obsess over these funds here. Some of them make a lot of sense, such as people fixating on funds' early, stellar returns, rather than looking long-term, and an emphasis on assets under management, rather than actual returns.