A legendary manager of hedge funds warns investors away

When Michael Steinhardt tells you not to invest in hedge funds, you had better take notice. Steinhardt left the hedge fund business in 1995 after running one of the most successful funds ever. He wrote a recent guest editorial in The New York Times excoriating the industry’s marketing and warning most investors to avoid such funds. “As recent history shows, the outsized expectations attached to the hedge fund mystique cannot be matched by performance across the board,” he wrote. Steinhardt said hedge funds remain appropriate for wealthy investors who can afford to gamble with small amounts of their net worth. But the risky funds are dangerous and should be avoided by ordinary investors.

The industry has grown to $1.5 trillion in assets mainly because it is a lucrative pursuit for managers. “Realistically, there are a limited number of truly superior fund managers,” he wrote. “Yet legions of managers earn extraordinary compensation for what, as the indices reveal, has been ordinary performance.” Hedge fund performance is dismal these days, he said. Since the stock market bottom in 2002, a major index of hedge fund performance was beaten by the U.S.stock market in two out of three years. From 1993 through 2005, the same index matched the total return of the Standard & Poor’s 500 Stocks index.

This is a far cry from the traditional goal of hedge funds, which was to beat the market, he noted. With so many competing funds, it is impossible for investors to identify the few who will beat the market, he said. “Even the most sophisticated investors will be challenged, confirming once again that hedge funds are not designed for the masses,” Steinhardt concluded.