Former Bridgewater Associates LP executive Bob Elliott’s plan for exchange-traded funds that employ hedge fund strategies has sharpened the debate about whether retail investors should have access to such approaches.
The answer broadly is yes, though mostly for investors who understand how these strategies work within a broader portfolio. A second question is whether such sophisticated active management belongs in an ETF format versus an open-end public mutual fund. We’ll need a short dive into history to understand these debates better.
Public open-end mutual funds were created in the 1940s by the Securities and Exchange Commission, which forbade or discouraged leverage, derivatives and concentrated positions, making it pretty much impossible to beat the market. More significantly, it forbade performance fees. The result was excessive management fees and returns that consistently lagged the market. The two types of public mutual funds that helped investors — index funds and money market funds — were initially resisted by the SEC.
These shortcomings pushed wealthy investors into private funds. Eventually named “hedge funds,” although not all of them hedged, the funds lived by performance fees rather than management fees, thus prioritizing returns over sales. In fact, many of the most successful closed to outside investors and ran only for the benefit of founders and employees.