Please take a moment to remember the 3.3% decline in the Dow, which occurred less than a month ago (and was caused by the sell off in Asian markets). Now, look at your performance reports. You’ll notice that your investments are up for the quarter by two to three percent, which is a great quarterly return. It always amazes me how quickly the stock market can rebound! Sometimes, it goes down for several years before it rebounds, but when the rebound occurs, it is usually fast and unexpected. This is why “market timing” is such as waste of time. You are always better off to stay invested during tough times then to pull your money out and try to “jump back in” when the markets are recovering.
Given the natural volatility of the stock market from year to year, more attention is being drawn to hedge funds, which claim to profit whether markets go up or down. Until recently only very wealthy investors could get into hedge funds. However, in recent years, funds of hedge funds have been offered to smaller investors with as little as $25,000 to plunk down.
They are touted as a diversification from stock market risk because hedge funds have the ability to sell stocks and other investments short and to move in and out of different investment markets instantaneously. Because they are largely unregulated, they can also use exotic investment vehicles such as derivatives.
A new study by Mark Kritzman, president of a Boston-based money management firm and an instructor at the Sloan School of Management at MIT, questions whether investors can gain any performance edge by using hedge funds. The study, “Portfolio Efficiency with Performance Fees,” was published in Economics and Portfolio Strategy, a newsletter for institutional investors. He found that hedge funds have a big drawback: the typical hedge fund charges a basic 2% asset management fee, and it gets to keep 20% of profits above a benchmark.
He put together a hypothetical portfolio of 10 hedge funds and calculated the fees and returns. He assumed the funds would earn 7 percentage points more than the assumed benchmark, the London Interbank Offering Rate, an index of short term interest rates. He found that the 2-and-20 fee arrangement would cost the investor 3.8 percentage points per year, and the after-fee return on the hedge funds would be 8.6% a year. The hedge funds levied an “asymmetric penalty” by keeping some of the profits but not giving up anything when they were unprofitable, he said. The hedge funds offered a lower return than a simple portfolio of indexed stock and bond mutual funds, he said.
Now, in order to comply with the provisions of the Gramm-Leach-Bliley Act, I am enclosing a copy of KFP’s Privacy Statement for your review. The Privacy Act requires that I deliver this to every client on an annual basis. In addition, as a Registered Investment Advisor, Keystone Financial Planning is required by state regulators to offer you a copy of Part II of Form ADV. The Form ADV is KFP’s registration with the Pennsylvania Securities Commission. If you would like a copy of Form ADV Part II, you may download it by going to the “Regulatory Compliance” page on KFP’s website (www.KeystoneFP.com). Please feel free to call me if you would like a copy mailed to you.
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About Christopher Jones
Christopher Jones is the Founder and President of Sparrow Wealth Management, a fee-only financial planning and investment management firm. Before entering the investment field, Chris was a management consultant for Deloitte Monitor. He graduated summa cum laude from Brigham Young University with a B.S. in Economics and a minor in Business Management.