Hedge funds have a glamorous reputation. They are often marketed on the strength of skilled managers, flexible strategies and protection when markets fall. For pension plans and endowments, they have become a common part of the portfolio. But do they deliver? Academic and policy research points to real costs and real risks, along with a few points in their favor. This article summarizes what several recent studies found, so investors can weigh the evidence for themselves.
Hedge funds are investment pools that, according to the IMF, invest and borrow with relatively few constraints. That freedom lets them hold illiquid assets, use extensive leverage and change positions quickly.4 The industry is large. The IMF puts gross assets at about $13 trillion, with gross notional exposures, which include positions on and off the balance sheet, of about $40 trillion. Institutions are major users. Ennis reports that hedge funds make up roughly 7% of public pension assets and 18% of large endowment assets.1
Hedge Funds in Institutional Portfolios
Approximate share of assets held in hedge funds, as reported in 2024
Source: Richard M. Ennis, CFA, "Hedge Funds: A Poor Choice for Most Long-Term Investors?" CFA Institute Enterprising Investor, June 26, 2024. Figures are approximate, as reported by the author.
View data table
| Investor type | Share of assets |
|---|---|
| Public pension plans | About 7% |
| Large endowments | About 18% |
The traditional hedge fund fee structure is often described as "2 and 20": 2% of assets each year, plus 20% of profits. Research by Ben-David and co-authors, cited by CFA Institute researcher Richard Ennis, suggests the effective cost may be higher. About 60% of the gains on which incentive fees were earned were later offset by losses, yet investors generally did not get the fees back. As a result, the researchers estimated the effective incentive rate was about 50%, not 20%. They put the industry's average annual cost at about 3.44% of assets from 1995 to 2016.1
Stated vs. Estimated Effective Incentive Fee
Share of hedge fund profits paid as incentive fees; researchers' estimate for 1995–2016
About 60% of the gains on which incentive fees were earned were later offset by losses, yet investors generally did not get the fees back. Estimated average annual industry cost: about 3.44% of assets, 1995–2016. These are researchers' estimates, not fees charged by any particular fund.
Source: Ben-David et al. (2023), as cited in Richard M. Ennis, CFA, "Hedge Funds: A Poor Choice for Most Long-Term Investors?" CFA Institute Enterprising Investor, June 26, 2024.
View data table
| Measure | Rate |
|---|---|
| Stated incentive fee | 20% of profits |
| Estimated effective incentive rate | About 50% of profits |
| Estimated average annual cost, 1995–2016 | About 3.44% of assets |
Ennis writes that hedge funds performed very well before the 2008 global financial crisis and that results then faded. For the 15 years ended June 30, 2023, the period Ennis studied, the HFR Fund-Weighted Composite Index returned 4.0% annualized. The index is an equal-weighted index of single-manager hedge funds that report to HFR, with returns reported net of all fund fees. A hypothetical blend of 52% stocks and 48% Treasury bills, built by Ennis after the fact to match the composite's market exposure and risk, returned 4.5%. That is a gap of about 0.5% per year for the period studied.1 No investor earned the blend's return, and it reflects no fees, trading costs or taxes. Results over other periods may differ, and past performance is not a guarantee of future results. The purpose of this comparison is to show what a simple mix of stocks and Treasury bills with similar market exposure and risk would have returned. Unlike the hedge fund composite, the blend is a constructed benchmark rather than an investment product. The blend is a benchmark constructed by the study's author and does not reflect an actual portfolio. Investors cannot invest directly in any index. Individual investor accounts (performance, allocation, etc.) may vary.
Hedge Fund Composite vs. a Hypothetical Stock and T-Bill Blend
Annualized return, 15 years ended June 30, 2023 (the period studied by Ennis)
Gap: about 0.5% per year. The blend was built after the fact by the study's author to match the composite's market exposure and risk; no investor earned its return. The blend reflects no fees, trading costs or taxes; HFR index returns are net of all fund fees. Neither figure represents an IFA portfolio or client account.
Source: Richard M. Ennis, CFA, "Hedge Funds: A Poor Choice for Most Long-Term Investors?" CFA Institute Enterprising Investor, June 26, 2024. Return figures are from the author's analysis; the benchmark is a returns-based blend.
The blend is a benchmark constructed by the study's author and does not reflect an actual portfolio. Investors cannot invest directly in any index. Individual investor accounts (performance, allocation, etc.) may vary. Results for other periods may differ. Past performance is not a guarantee of future results.
View data table
| Series | Annualized return |
|---|---|
| HFR Fund-Weighted Composite Index | 4.0% |
| Hypothetical 52% stocks / 48% Treasury bills blend | 4.5% |
| Difference | About −0.5% per year |
Ennis also studied 54 U.S. public pension funds. Funds with larger hedge fund allocations tended to have lower returns relative to their benchmarks. An average allocation of about 7.3% was associated with roughly 0.55% less return per year. Each fund's benchmark was built by Ennis using returns-based style analysis, so the comparison is an estimate, and the result is a statistical association.1 Another finding: hedge funds usually carry far less stock market exposure than many investors assume, often just under half. Swapping stocks for hedge funds can therefore lower an investor's equity exposure in ways that may not be obvious.
Ennis offers several possible reasons for the fade without settling on one. Hedge fund assets grew roughly tenfold between 2000 and 2007, and he suggests that rapid growth may have been a factor. A 2008 accounting rule change required private assets to be valued on a market basis, and research he cites finds that this reduced the upward bias in reported valuations. The 2010 Dodd–Frank reforms may also have chilled some profitable trading. These are possible explanations, not proven causes, and the scholarly literature on hedge fund performance remains mixed.1
Ennis argues that investors make a conceptual mistake when they decide to put a set percentage of a portfolio into hedge funds as a category. He calls this the asset class fallacy: it makes picking a group of winning funds sound routine, and it is not. In his view, the category itself has little to offer, so any allocation should depend on the opportunity in specific funds.1
There is a trade-off in spreading money across many managers. In his illustrative example, using four managers instead of one cuts active risk in half. Adding more produces only small further reductions and can dilute the impact of the best managers. The example is theoretical and assumes equal-sized investments and uncorrelated managers.1
Some hedge funds buy stakes in public companies and press for changes. A 2020 Strategic Management Journal study of 1,324 activist campaigns from 2000 to 2016 found a trade-off. Benefits to shareholders, such as immediate gains in market value, were short-lived. Over the mid to long term, the study found declines in operating cash flow, investment spending and social performance.2 Not all research agrees. A 2008 Journal of Finance study of earlier campaigns found a gain of about 7% around the announcement of activism, with no reversal over the next year, along with improved operating performance at target firms.3 Because studies differ in periods, methods and comparison groups, the debate remains unsettled.
Other research adds to the picture. A press release from HEC Paris on the DesJardine and Durand study says it compared the 1,324 targeted companies with 7,670 control companies, and reported declines in market value and social responsibility performance four and five years after the intervention.5 Separately, a working paper by Andrew Baker that accounts for how activists pick their targets found no evidence of improved operating performance or significant long-term returns when targets were compared with similar firms. It did find higher payouts to shareholders, lower investment and falling employment after campaigns.6
Hedge fund assets have tripled since 2013, to about $13 trillion in gross assets, and hedge funds held about 9% of U.S. Treasurys in 2025, according to a recent IMF blog post. The IMF's authors say hedge funds can support liquidity and price discovery in normal times. In stressed markets, however, leverage, crowded positions and investor withdrawals can force rapid selling. In the IMF's analysis, the stocks most widely held by hedge funds were about 10 percentage points more volatile than the least crowded stocks, and had peak-to-trough losses about 4 percentage points deeper during stress periods. The authors add that losses at hedge funds can also weigh on the large banks that lend to them, and that stress can spill across borders into other countries' stock markets.4
The IMF describes how stress can build. Hedge funds borrow through repurchase agreements, prime broker credit and derivatives. When volatility rises or financing tightens, margin calls can force funds to cut exposures or unwind positions. If many funds hold the same crowded positions, or investors withdraw at the same time, selling can feed on itself: losses lead to deleveraging, which leads to more withdrawals and more losses. The IMF found that leverage amplified the volatility and losses it measured. It also notes that many authorities lack complete information on hedge fund leverage, derivatives exposure and cross-border activity, and it recommends better monitoring and reporting.4
How Hedge Fund Stress Can Feed on Itself
The deleveraging cycle described by the IMF
- Volatility rises or financing tightensHedge funds borrow through repos, prime broker credit and derivatives.
- Margin callsMargin calls can force funds to cut exposures or unwind positions.
- Funds cut exposures or unwind positionsIf many funds hold the same crowded positions, selling can feed on itself.
- LossesLosses lead to deleveraging.
- Deleveraging and withdrawalsDeleveraging leads to more withdrawals and more losses.
Leverage amplified the volatility and losses the IMF measured. In the IMF's analysis, the most crowded hedge fund stocks were about 10 percentage points more volatile than the least crowded, with peak-to-trough losses about 4 percentage points deeper during stress periods.
Source: Andrea Deghi, Taneli Makinen, Mahvash S. Qureshi and Felix Suntheim, "Hedge Funds Improve Market Functioning, but Can Also Amplify Stress," IMF Blog, October 6, 2026. Diagram is a simplified illustration of the process described.
Hedge funds are not a single investment. They use many strategies, and they invest and borrow with fewer constraints than mutual funds.4 That makes them hard to measure. Ennis cautions that results depend on the data source, the time period, and how the comparison benchmark is built.1 For that reason, a single percentage should be read as one estimate within a range, not a final verdict.
A fair reading includes points in hedge funds' favor. Ennis himself notes that the research on hedge fund performance is mixed. He cites a 2023 study suggesting a newer group of hedge funds, ones not reported to commercial databases, produced stronger returns than those that are. He also acknowledges that exceptionally skilled managers likely exist, and that a small allocation to a few of them might be justified. The challenge is identifying such managers in advance. The IMF, for its part, credits hedge funds with improving how markets function in normal times.
The research does not say every hedge fund is a poor investment. The studies summarized here do suggest the average hedge fund has been costly, that a hedge fund index trailed a simple benchmark over the 15 years ended June 30, 2023, and that hedge funds can add risk to the financial system in a crisis. Investors considering any alternative investment should understand the full fee structure, how much leverage is used, how easily they can withdraw their money, and how the investment fits their overall plan. A complex, high-cost strategy has to clear a high bar.
Having read these studies, I come away skeptical. The fees are heavy. In the 15 years Ennis measured, a hedge fund index trailed a hypothetical mix of stocks and Treasury bills that he built for comparison. And the borrowing some funds use can make a bad market worse. A few managers may well be excellent, and I wouldn't argue otherwise, but I haven't seen persuasive evidence that investors can reliably pick them in advance. So if someone offers you a hedge fund, ask what you will really pay, how much of it is borrowed, and how easily you can get your money out. Then ask how it compares with the other options available to you.
Index Fund Advisors manages index-based portfolios and does not offer, recommend or receive compensation from any hedge fund or alternative strategy, and the author is Mark Hebner founder and CEO. Readers should weigh the views expressed here with that in mind. These views are the author's as of October 2026 and may change.
This article is general information, not tax, legal or investment advice. Past performance is not a guarantee of future results. Investing involves risk, including loss of principal.
