On The Contrary: Outside The Hedge Funds, Looking In

ITS time for wise investors to start listening to Marx. But put away your college copy of Das Kapital because Im talking about the well-known social theorist Groucho Marx, the man who famously said he wouldnt want to belong to any club that would have him as a member.

I was reminded of Groucho when I heard that several investment firms were offering index investment products intended to passively mimic the performance of hedge funds, the popularity of which seems to know no bounds nowadays.

The number of these relatively unfettered investment pools is growing by leaps and bounds, as is the money they have under management. At last count, there were more than 9,200 hedge funds running a total of $1.3 trillion or more in capital.

Hedge funds are becoming so numerous — and therefore so relatively accessible — that the Securities and Exchange Commission is proposing to require that hedge fund investors have at least $2.5 million in investable assets, compared with a current minimum of $1 million. (You can also get in if your income is high enough.) In the short term, this may shut out the merely moderately rich, but its unlikely to stanch the flow of money into hedge funds or halt the gradual democratization of hedgelike vehicles.

As if big investors didnt have enough choices, Merrill Lynch said recently that it had begun offering them its Factor index, which seeks to provide something like generic hedge fund performance at low cost and with high liquidity. Goldman Sachs, meanwhile, has introduced a similar product in Europe called its Absolute Return Tracker index, which it hopes to market eventually in the United States.

The advent of indexes that try to approximate hedge fund performance on the cheap sounds like a positive development all around. It could, for example, exert downward pressure on steep hedge fund fees, which can be 2 percent of assets off the top and 20 percent of profits.

But the rise of investment vehicles based on hedge fund indexes suggests that, soon enough, average investors may get a piece of the action. If there are hedge fund indexes, after all, can mutual funds be far behind?

Well, no. As a matter of fact, several mutual funds already offer people like you and me access to something like a poor-mans hedge fund. These funds use puts, calls and short-selling, among other hedge-fund-type strategies, and in the eyes of some advisers offer useful diversification for investors (not to mention hefty fees for the fund managers).

The problem with all of this is that hedge funds, in the aggregate, are a lousy investment. With so much money chasing so few ideas, not to mention the handicap of such high expenses, how could they be otherwise?

Since 1993, the Credit Suisse/Tremont Hedge Fund Index has generated returns roughly on a par with the Standard & Poors 500-stock index, an investment available to widows, orphans and just about everybody else through index funds offered at rock-bottom prices by Vanguard and some of its competitors.

Thanks to the wide range of tactics and techniques they use, hedge funds may deliver somewhat less volatility, but on the other hand they are tax-inefficient because of all their trading. So on an after-tax basis, an investor would have probably done worse in the average hedge fund than in the S.& P. 500.

My bet is that this trend will continue. Unless youre somehow in the know, fabulously wealthy, have some special ability to identify great hedge funds and gain the privilege of investing in them — hedge funds in the years ahead are likely to be a suckers game.

Thats why I expect that, before too long, theyll find some way to let the suckers in. (In the foreseeable future these will still be rich ones, assuming that the proposed new S.E.C. rule on investable assets takes effect.)

Calling something a hedge fund doesnt change the fact that in the long run — the only sensible period for which investors should accept much risk — its very hard for anyone to beat the financial markets consistently, especially after taxes and expenses. Its probably just as hard to identify others who can consistently beat the markets.

If youre an average investor, consider yourself lucky to be shut out of hedge funds. If youre rich, why bother? There are safer ways to buy status. But if youre smart, what you want to do with a hedge fund is to start one, because thats the most reliable way to profit from them.

Daniel Akst is a journalist and novelist who writes often about business. E-mail: culmoney@nytimes.com.

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