Savings accounts outperform hedge funds

Hedge Funds are failing to live up to their considerable hype and hubris. Indeed, fund managers in general are not earning their keep, and most investors should stick with an ETF or index tracker.

With stockmarkets reeling from the near-collapse of Freddie Mac and Fannie Mae, it's been a rotten week for investors. And none more so than Bill Miller, the legendary American investor. His fund, the Legg Mason Value Trust, is down 40% this year. And it's destined to fall further now that his big punt on Freddie Mac, which he bought when it was down just 25%, has failed to pay off. It's another blow for a manager who managed to beat the S&P 500 for 15 years on the trot from 1990. But at least Miller has that track record to look back on as a study from Canada reveals, he is hardly the only fund manager to fail to beat his benchmark index.

In the first quarter of 2008, only 8.2% of actively managed Canadian equity funds managed to beat the Toronto Stock Exchange (S&P/TSX), which dropped almost 4%, according to Standard & Poor's Index Versus Active Funds Scorecard. "Flip it around and it's saying 93% of actively managed Canadian equity funds failed to justify their fees and beat the index," says Jonathan Chevreau in Canada's Financial Post.

And it's not just Canada, says Standard & Poor's. A full 68% of active international equity fund managers failed to beat their benchmarks in the last 12 months; 64% of US managers were unable to beat the S&P 500. In other words, a majority of investors would have been better off leaving their money in an exchange-traded fund (ETF) or index tracker, where they would have shelled out about a third of the fees levied by the likes of Miller and his fellow fund managers.

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Meanwhile, hedge funds, which are supposed to make money in both good markets and bad, are having a tough time living up to their hype. According to Hedge Fund Research, the average hedge fund lost 0.75% in the six months to June after fees the worst first half since 1990. Not bad, perhaps, compared with stockmarkets, but still a far worse return than you'd have got in a savings account, and certainly not the absolute return that you're apparently paying those hefty fees for.

The good news is that investors, large and small, are getting the message and putting more money in ETFs. Of institutional investors, 44% now use ETFs, against 13% in 2006, according to the eighth European institutional asset management survey by Invesco. They offer easy exposure to hard-to-reach areas, such as Pakistan, and they are cheaper than actively managed funds.

But where should MoneyWeek readers be putting their money right now? Both iShares and Liontrust run a range of ETFs that track different market indices, for example the FTSE 100 and FTSE 250. But given the parlous state of the markets you might be better plumping for a 'short ETF', which goes up when the markets go down. Deutsche Bank launched its X-trackers FTSE 100 Short ETF (LSE:XUKS) last month.