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Fiduciaries Should Ask This Very Question

An esteemed ERISA litigation lawyer e-mail me the other day with a question, as follows: “Mitch, would you advise an ERISA plan NOT to invest in a hedge fund which uses an “expert network”, in light of the controversies surrounding network experts?”

My reply, “I have lots of issues with hedge funds, though the use of experts is low on my list.”

In my judgment, the overwhelming concern with hedge funds is whether the fees paid to the hedge fund managers are reasonable.

On the whole, hedge fund performance is somewhat average, mediocre.   Just what would be expected in light of the vast number of hedge funds. Paying the standard “2 and 20” management fee for mediocre performance is hard to justify as prudent. (Check out out, https://www.hedgefundresearch.com, for data on hedge fund performance.)

Sure, some hedge funds have outperformed the market significantly.  But, this assessment, as is always the case, is in retrospect.  Just like selecting active managers, the question is whether the managers can be identified beforehand.

Choosing an out performing hedge fund (thereby justifying high management fees) is further exacerbated by the fact the US equities market has been on an upward trajectory since 2009.   The S&P 500 is up 150% (dividends reinvested) with an annualized return in excess of 18%.

Outperforming, where it occurs, in an overwhelmingly up market is not an impressive accomplishment.  Effectively assessing a manager’s investment skill requires investment performance over an entire market cycle, up as well as down markets.

My prediction is that when the market eventually reverses itself, and over time it certainly will, the class action lawyers are going to catch wind of this issue.  Private litigation will eventually explode in this arena.

Hopefully, fiduciaries will have done their homework.

As for expert networks?  Fiduciaries must undertake their due diligence of the compliance processes employed my hedge fund managers.  Its enough to say, “Please, no insider trading.”  Instead, assure yourself that compliance processes are sophisticated and reflect best practices.

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