Money managers are supposed to be experts in managing money. But their performance in the US have been very average

Money managers either of hedge funds, mutual funds pension funds or sovereign wealth funds are some of the best-compensated individuals on earth. They are supposed to use their expert knowledge of markets, finance and economics to deliver outstanding returns to their clients, but do they? Are they worth the faith put in them by hard working people whose pensions they manage or the citizens whose funds they invest? Do they add value or additional returns over a random selection or investments? In short, are they worth the money? The sad truth is probably not.

Let us start with the stars of money managers: hedge funds and private equity. These financial geniuses and deal makers are paid literally billions to invest other people's money, but do they actually make money?

Hedge funds, when they were new, did make a lot of money. According to Chicago-based data provider Hedge Fund Research between 1990 and 2000 hedge funds were able to achieve an astonishing annual return of 18.74%. They did this by exploiting opportunities in markets. Of course the great thing about competitive markets is that success breeds competition subsequently driving down prices. Over the more recent past, between 2000 and 2007, hedge fund returns have been far more modest, just an 8.61%.

Normally an 8.61% return would be considered ample, but not with hedge funds. These celebrity hedge fund managers command large fees. The old standard in the industry, 2 and 20, (2 % of assets, and 20% of profits) required hefty returns just to break even. A return of 8.61% would be reduced by 3.7% in fees. So the real return would be less than 5%, a return that is often available on investments with little or no risk.

But there can be more fees. Hedge fund managers' methods and strategies are often arcane and filled with all the mystery that the name 'black box' implies. How can investors choose between them? Enter the Fund of Funds (FOFs). To be safe we are supposed to diversify our hedge fund bets in many different funds chosen by another group of highly paid money managers.

And what do investors get for these extra charges? Not much. This year regular hedge funds are down about 2%, and that does not include the 2% management fee! FOFs did even worse. They are off more than 6%! It is not surprising that the FOFs' share of hedge funds assets under management has fallen from 43% to 34%.  Worse, one of the justifications for fund of funds is that they have access to the best hedge funds. This might be a selling point except that one of the exclusive hedge funds that these managers chose was run by Bernard Madoff. The issue of Madoff is important for another reason, transparency. According to a study by New York University's Stern School of Business one in five hedge fund managers misrepresents their fund or its performance to investors. 

What about private equity? What do investors get for the risk of tying up their money for possibly years and the extra fees? Very little. According to a recently published survey only half of the investors in private equity deals are seeing returns above 10%. Two years ago only a fifth has such small returns. The number of successful investors with returns greater than 15% has fallen from 40% to 20%. But perhaps the biggest indictment of private equity has to do with the firm Kohlberg Kravis Roberts (KKR).

KKR is the legendary private equity firm. The subject of both books and even a film, it has been around since 1976. The firm is now going public. According to filings in 2007, the firm estimated its worth to be over $25 billion. It is now estimated to be worth only $6.4 billion a decline of 76%. The shares of the founders Henry Kravis and George Roberts have declined from $6 billion each to $800 million.

It is understandable that risky hedge funds and private equities might variable returns, but what about the plain old run of the mill mutual funds. Surely these are conservatively managed with consistent returns? Well no. In the past two decades actively managed mutual funds in the aggregate have failed to beat the indexes. So investing in index funds like an Exchange Traded Funds (ETFs) has proved to be more profitable than investing in a fund managed by an experienced, intelligent individual. Over the past 30 years fund managers have been underexposed in bull markets and overexposed in bear markets. Basically, they always end up chasing the markets and following the herd.

One would think that a human might be able to beat the averages, but that is really the problem. Managers don't beat the averages, because they are human. They fall prey to instincts and cognitive biases. In fact one of the most successful managers essentially did nothing at all. For the past 20 years he parked 80% of his money in money market funds. In other words, cash.

(The writer is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected]).