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Why You Should Be Skeptical About Hedge Fund Managers

In this video, author Jack Schwager tells us how hedge funds are often only as risky as the market. If you're looking for some ways to hedge against risk yourself, becoming a dividend investor may be the key. For a few long-term investing ideas, let me invite you to read the Fool's brand-new special report, "The 3 Dow Stocks Dividend Investors Need." It's absolutely free, so just click here and get your copy today.

Brendan: How about hedge fund managers? How do you evaluate them? How do you know what's luck and what's skill?

Jack: Yeah. Well, the first thing to ask yourself is, "Are the manager's returns the result of a market?" One chart I have in the book is, I take equity hedge fund managers who like to claim that they're uncorrelated to the market ... yeah, really.

Brendan: Right.

Jack: I superimpose it over the S&P, that index, and you can very, very clearly see that relationship. The interesting part is in that first five years, where they're both going up kind of in line.

That index representative of any equity hedge fund manager, you could look at him and you'd say, "Oh, he doesn't have much risk. He's fine. He's low-risk, he's making money," not understanding that the reason he's making money is because the index is going up. As soon as the index would go down, he would go down, and that's exactly what happened.

The first thing to ask yourself is, "How related is that manager's performance to an underlying market, or to assuming some other risk, like liquidity risk or credit risk?"

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