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The investment climate has been almost manic over the last year, with wild swings in global markets due to economic news and the financial crisis in Europe. At times like these some in the investment world argue that passive investors who sit on a diversified portfolio will get whipsawed. Instead, the argument goes, they should hand their money to an expert who can react quickly to market moves and make investments that hedge against sudden declines.
That is, of course, what hedge funds try to do. These lightly-regulated investment pools open only to wealthy investors are allowed to go anywhere and do anything to offer high returns and to avoid big declines. A typical hedge fund one day may buy Australian dollars while betting against the Japanese yen, and the next short U.S. stocks while buying Swiss bonds.
Hedge funds that made big bets based on economic trends got very popular after the 2008 bear market. At that time it looked like some hedge funds had protected their investors from the sharp declines in stock prices. This year, however, it isn’t working. The Wall Street Journal reported in early August that many funds were not able to keep up with fast-moving markets.
Last year the average hedge fund lost 4.2 percent, compared to a slight gain in big American stocks. During the first half of this year, the average fund lost 0.5 percent while the Standard & Poor’s 500 Stocks Index gained 9.5 percent. Hedge Fund Research Inc. noted that investors withdrew $3.5 billion from these funds in the second quarter. Several funds have returned money to their investors, saying they could not deploy it effectively. Once again it appears diversified investors have beaten the pros.