Numerous academic research papers had consistently shown hedge funds are able to beat the market and proved the “efficient markets” theory is not that accurate or reliable. This theory says that markets are extremely efficient (incorporates all relevant investment information into its pricing mechanisms) over the long term but hedge funds have shown markets are inefficient in the short term. These short term inefficiencies or temporary distortions are exploited by hedge fund managers to garner above-market returns year in and year out, yielding higher returns over the same longer-term time frame. In fact, George Soros’ Quantum Fund had averaged high returns of 33% over a 30-year period. This performance easily beat market returns over the same period and had academicians questioning their own assumptions.
However, recent proliferation of hedge funds had resulted in the migration of the same base or pool of money managers from traditional investments to alternative investments such that the premium performance expected from the prior set of really talented fund managers has somehow diminished. Most new hedge funds also invest in the same type of asset class or pursue the same investment strategy resulting in no significant differentiation among them. Danger lurks when these hedge funds attempt to exit the same investment instruments simultaneously (as during an event that triggers investor panic) resulting in a liquidity crisis because of suddenly crowded, chaotic, and disorderly trades. There are only 2 emotions investors had exhibited ever since stock markets were formed: needless fear (panic) which can have no floor and irrational exuberance (greed) which has no ceiling either. Hedge funds are no different from individual stock market players or investors. The same mentality prevails.