Key Takeaways
- • Research cited by Index Fund Advisors estimates the effective incentive rate on hedge funds at about 50% rather than the nominal 20%, with average annual cost near 3.44% of assets from 1995 to 2016, according to Ben-David and co-authors as cited by CFA Institute's Richard Ennis.
- • The HFR Fund-Weighted Composite returned 4.0% annualized over the 15 years ended June 30, 2023, versus 4.5% for a constructed 52% stock / 48% T-bill blend, a gap of about 0.5% per year before fees, trading costs and taxes.
- • Ennis found that public pension funds with average hedge fund allocations of about 7.3% earned roughly 0.55% less per year relative to benchmarks, a statistical association rather than proven causation.
- • The IMF reports hedge fund gross assets of about $13 trillion and gross notional exposure of about $40 trillion, and says leverage, crowded positions and redemptions can amplify market stress.
- • The article concludes that the average hedge fund has been costly and that a few skilled managers may exist, but that investors cannot reliably identify them in advance.
Summary
An opinion piece from Index Fund Advisors, Inc. (IFA), authored by founder and CEO Mark Hebner, reviews academic and policy research on whether hedge funds deliver on their marketing. The article cites the IMF's estimate of roughly $13 trillion in gross assets and about $40 trillion in gross notional exposure, and Ennis's finding that hedge funds make up roughly 7% of public pension assets and 18% of large endowment assets. Hedge funds are described as investment pools with relatively few constraints on leverage, illiquid holdings and trading.
On costs, the article contrasts the traditional "2 and 20" fee structure with research by Ben-David and co-authors, cited by Ennis, which estimated that about 60% of gains on which incentive fees were earned were later offset by losses without fee refunds. That implies an effective incentive rate near 50% and an average annual industry cost of about 3.44% of assets from 1995 to 2016.
Performance research cited includes Ennis's comparison of the HFR Fund-Weighted Composite, which returned 4.0% annualized for the 15 years ended June 30, 2023, against a hypothetical 52/48 stock and T-bill blend that returned 4.5%. The article notes the blend is a constructed benchmark that reflects no fees, costs or taxes, and that results over other periods may differ. Ennis's study of 54 U.S. public pension funds found that higher hedge fund allocations were associated with lower returns relative to benchmarks, with an average 7.3% allocation linked to about 0.55% less annual return. Ennis offers possible explanations for the fade in hedge fund returns after 2008, including rapid asset growth, a 2008 accounting change and the 2010 Dodd-Frank reforms, while stressing these are not proven causes.
On activism, the article cites a 2020 Strategic Management Journal study of 1,324 campaigns (2000 to 2016) finding short-lived shareholder gains and later declines in operating cash flow and investment, a 2008 Journal of Finance study finding a roughly 7% announcement gain with no reversal, and a working paper by Andrew Baker finding no improvement in operating performance versus similar firms. On systemic risk, the IMF reports hedge funds held about 9% of U.S. Treasurys in 2025, and that heavily crowded stocks were about 10 percentage points more volatile and had peak-to-trough losses about 4 percentage points deeper during stress. The article concludes that while a few managers may be excellent, persuasive evidence that investors can reliably select them in advance is lacking, and it advises investors to scrutinize fees, leverage and liquidity terms before committing.
On costs, the article contrasts the traditional "2 and 20" fee structure with research by Ben-David and co-authors, cited by Ennis, which estimated that about 60% of gains on which incentive fees were earned were later offset by losses without fee refunds. That implies an effective incentive rate near 50% and an average annual industry cost of about 3.44% of assets from 1995 to 2016.
Performance research cited includes Ennis's comparison of the HFR Fund-Weighted Composite, which returned 4.0% annualized for the 15 years ended June 30, 2023, against a hypothetical 52/48 stock and T-bill blend that returned 4.5%. The article notes the blend is a constructed benchmark that reflects no fees, costs or taxes, and that results over other periods may differ. Ennis's study of 54 U.S. public pension funds found that higher hedge fund allocations were associated with lower returns relative to benchmarks, with an average 7.3% allocation linked to about 0.55% less annual return. Ennis offers possible explanations for the fade in hedge fund returns after 2008, including rapid asset growth, a 2008 accounting change and the 2010 Dodd-Frank reforms, while stressing these are not proven causes.
On activism, the article cites a 2020 Strategic Management Journal study of 1,324 campaigns (2000 to 2016) finding short-lived shareholder gains and later declines in operating cash flow and investment, a 2008 Journal of Finance study finding a roughly 7% announcement gain with no reversal, and a working paper by Andrew Baker finding no improvement in operating performance versus similar firms. On systemic risk, the IMF reports hedge funds held about 9% of U.S. Treasurys in 2025, and that heavily crowded stocks were about 10 percentage points more volatile and had peak-to-trough losses about 4 percentage points deeper during stress. The article concludes that while a few managers may be excellent, persuasive evidence that investors can reliably select them in advance is lacking, and it advises investors to scrutinize fees, leverage and liquidity terms before committing.
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