In this finance explainer, Chris Haroun argues that hedge funds have dramatically underperformed the S&P 500 since the 2008 financial crisis, while still charging high fees. He attributes this secular decline to four main forces: (1) stricter securities regulation, especially the 2002 Regulation FD, which removed the information advantage hedge funds once enjoyed; (2) the explosive growth of low‑fee exchange‑traded funds (ETFs) that increase market correlation and make it harder for active managers to add value; (3) the rise of computer‑driven and AI‑based trading that rapidly arbitrages away mispricings, shrinking opportunities for hedge funds; and (4) the emergence of coordinated retail investors who target heavily shorted stocks, forcing costly short‑covering squeezes (e.g., GameStop, AMC). Haroun also explains the traditional purpose of hedge funds—capital preservation and appreciation for wealthy investors—and concludes that, given these pressures, hedge funds are in a secular decline because their ability to generate alpha has been fundamentally compromised.
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Hedge funds have massively underperformed the S&P 500 since 2008. And the fees on hedge funds are ridiculously high as well. So higher fees doesn't mean high returns. And what's happened to hedge funds is a couple of things. Okay, a couple things have led to the massive underperformance of hedge funds over the past decade or so. Number one, the securities and Exchange Commission and the FBI have come after many hedge funds that were certainly guilty of insider information. And the investment laws actually started getting more strict starting in 2002 when the government created what's called Regulation FD, which stands for fair disclosure. And this is awesome for us. And I'll explain why this 2002 regulation is great. Because by law now, no hedge funds or mutual funds are allowed to get access to any company information before retail investors do. And this has hurt hedge fund performance. So the edge that hedge funds and mutual funds had on us is gone now post the 2008 bank bailout, the government has been pressured, rightly so, to go after many, but not all, hedge funds that violated securities laws. Because of course, it's not fair that they have an edge over retail investors. The second reason hedge fund performance has deteriorated is because of the massive growth of exchange traded funds, which have minimal fees. Now many investors prefer to invest, rightly so, in ETFs instead of hedge funds and instead of mutual funds, because those ETFs are often outperform hedge funds and mutual funds as well, with much lower fees. And since more people buy ETFs now, it makes the correlation between stocks much higher than it was in the past. Because when you buy an etf, you buy many stocks in that etf. And so if stocks tend to move more closely together now, it's harder for hedge funds or mutual funds to justify the ridiculous fees and outperform those indexes or stocks, which they don't because correlation is high. Okay, the third reason why hedge funds have underperformed a little bit is because of computer based trading. Now it's harder for hedge funds to now find mispriced assets or arbitrage opportunities because computers are starting to do this much more often. And with artificial intelligence based investing, expect this trend to of course, continue. Lastly, the fourth reason is because of the emergence of retail investors that team up to buy highly shorted stocks, which leads to unprecedented short covering by hedge funds in stocks like GameStop, AMC, etc. Which of course destroys hedge fund performance. So why do hedge funds even exist? Well, one of the reasons is because wealthy investors quite often want to focus on, number one, capital preservation, and then, number two, capital appreciation. And a hedge fund is actually called a hedge fund because if you think of your backyard, you have a hedge around your backyard protecting it. And using that analogy, you know, hedge funds protect capital. And again, many wealthy investors want to preserve their wealth should the market materially pull back. And I personally think that hedge funds are in secular decline because their ability to generate alpha, meaning beating the market, has been materially hurt. Given the four reasons I mentioned in this video,
