Are Hedge Fund managers turning towards Index Funds? | Index One (2024)

In this edition of Index One Insights by Index One, we explore why hedge fund managers are turning towards index funds and what this means for market players.

➡️ Subscribe to our bi-weekly newsletter to stay updated with current news in the index industry, insightful articles and new Index One features.

Are Hedge Fund managers turning towards Index Funds? | Index One

“For most people, the best thing to do is to own the S&P 500 index fund. People will try to sell you other things because there's more money in it for them if they do.” -Warren Buffet

“Brains, adrenaline, and confidence”: are these enough to outperform?

According to recent survey data from banking company BNP Paribas, hedge funds saw a return of 6.67% globally throughout 2023, 1.5% shy of their intended target rate. Comparatively, the S&P 500 produced a 24% return last year, allowing investors who embraced the simple strategy of investing in index funds to experience similar gains.

Hedge funds saw a return of 6.67% in 2023, while the S&P 500 celebrated a 24% return in the same year. This is not news as active strategies have seemed to fall short of outperforming the market.

This is not to say that active fund managers have not historically mitigated risks posed by markets from time to time. According to Neuberger Berman, “the passive argument ignores a number of important investor-specific considerations” and needs to consider wider time horizons and more data to truly understand the performances of each strategy.

It may not come as a surprise that a portfolio manager seeks out profitable investments – after all, it's their primary duty. However, hedge funds usually steer clear of index funds. Due to their substantial fees and clientele of affluent investors, these funds traditionally engage in sophisticated strategies aimed at outperforming the very index funds they are now embracing.

This growing dependency on index investing signals that hedge funds are desperately seeking stability.

In 2023, prominent hedge funds such as Citadel's Wellington fund or Sculptor's Och-Ziff fund delivered returns of 15.3% and 12.9%, respectively, showcasing their size and reputation. However, their performance paled in comparison to the staggering returns of the S&P 500 or the tech-centric Nasdaq-100, which soared to 55% during the same period.

One way these hedge funds were able to bounce back, although they still didn't meet expectations, was by "index hugging" – which means they started investing more like an index fund to try and improve their returns.

What would happen if hedge fund managers became passive managers?

• There will be less unique hedge fund managers and more standardization in index investing: One of these is that many hedge funds look almost indistinguishable from one another as they crowd into the same positions. This could have huge implications if the market were to shift for the worse and those funds were to act rashly in unison.
• Investors will be paying high fees for a simple and easy investing strategy: If funds are simply buying and holding what index funds are holding, then the people invested in them are paying far more for something that still underperforms the very indices they are trying to imitate.

High-net worth individuals: should they turn to index funds?

As a person's wealth increases, so does the effort required to maintain and safeguard those assets. Typically, individuals with substantial wealth seek and can justify tailored services in investment management, estate planning, and tax planning.

High-net worth clients are generally presented with a number of investing opportunities and ways to do so.

Historically, hedge fund managers cater to high-net worth individuals as managers aim to tailor investment strategies closely to high-net worth individuals and their investment goals. One type of strategy pitched to these investors is direct indexing.

Hedge funds cater exclusively to high-net-worth individuals, accredited investors, and major institutions like pension funds and college endowments, typically demanding a significant minimum investment. In contrast, index funds are accessible to the general public, requiring only a small initial investment.

A hedge fund typically incurs high expenses, amounting to at least a few percentage points of the assets under management. On the other hand, an index fund maintains very low expenses, often less than 0.1%.

The characteristics of hedge funds are attractive primarily to high-net-worth individuals, who consequently see no reason to prioritize cost-cutting measures and transition to index funds. Conversely, index funds are designed for individual investors seeking reduced fees and risks.

Building a Portfolio with Low-Cost Index Funds

Investors can strategically leverage low-cost index funds to access diverse asset classes within their portfolios. Utilizing low-cost index funds becomes a key strategy in achieving this balance, allowing investors to build a robust and diversified investment foundation.

Index One provides clients with the tools to create indices based on an active or passive strategy. These indices can be used in portfolios aiming to integrate index funds in their strategies. Find out how.

Unlock the power of data-driven investing with Index One.

Our proprietary indexing tools are designed to help you make informed decisions, manage risk, and achieve your financial objectives.

Create your own custom index with Index One's fully flexible and customizable indexing platform, with the ability to define universes, weightings, and more.

Leverage Index One's fully automated rebalancing capabilities based on predefined rules at any frequency and schedule, supporting a wide range of methodologies.

Deliver investment solutions seamlessly by utilizing Index One's multiple integration and dissemination options.

Save up to 90% on indexing costs by switching over to Index One, a trusted index provider amongst financial professionals.

Should index providers publish price return or total return values?

Mark T. Hebner, founder and CEO ofIndex Fund Advisors, Inc., has initiated a petition calling on index providers to publish total return values instead of price return values of their indices. This is because price return indices may not fully represent an index's performance accurately. “The impact of this omission is significant; dividends would have increased reported price-only index returns by an estimated annualized return of between two and three percent per year, or approximately twice the cumulative return, over the last quarter-century.” Do you believe index providers should disclose the total return value of their indices rather than price return values, and why?

Monthly Spotlight

Popular indices calculated by Index One. As of 22rd Mar 2024.

World’s First Police and Public Safety Index now on Smartleaf Asset Management

Index One, a leading tech-based index provider, is proud to announce that One 6 Research’s Police & Public Safety Index, calculated by Index One, can now be discovered on Smartleaf Asset Management.

Your next ETF starts with an index.

Seamlessly build your next custom index with Index One. Find out how.