BUSINESS
04/15/2013 12:19 pm ET

Hedge Fund Managers Rake In Billions Yet Can't Beat A Simple Index Fund

Many of us suck at our jobs. But only a few people can get exorbitantly wealthy doing so. These elites are called hedge fund managers.

Several of the world's top hedge-fund gurus took home billions of dollars in pay last year despite their inability to beat a simple index fund, according to the latest ranking of top hedge-fund money makers by Institutional Investors' Alpha magazine.

The rankings were first reported by the New York Times, which led off with the fact that a few of these managers actually did beat the market, which is sadly what counts for headline news when it comes to hedge funds.

Bridgewater Associates honcho Ray Dalio was No. 2 on the Institutional Investors list, with take-home pay of $1.7 billion, even though Bridgewater's top fund, Pure Alpha, returned just 0.8 percent last year.

In contrast, the S&P 500 gained 13.4 percent last year and returned nearly 16 percent when you include dividends.

For the uninitiated, "alpha" is a hedge-fund term meaning "more money than the average schlub could make." So if you generate "pure alpha," you are presumably crushing it in the returns department. That did not apply to Dalio's fund last year.

Alpha also escaped Steven A. Cohen, the art-hoarding founder of SAC Capital, which returned 13 percent last year, also trailing the market. Cohen still took home $1.4 billion, landing him at No. 3 on the list of top hedge-fund earners, enough to keep him in Picassos and mansions and lawyers to fend off swarms of insider-trading allegations.

But it's probably not fair to pick on Dalio and Cohen, who have outperformed the market in most years.

It is much, much more fair to pick on all hedge funds generally, which returned just 6 percent in 2012, their 10th straight year of underperforming the S&P 500, the Economist noted recently. That includes the generally awful year of 2008, when hedge funds are supposed to shine, on account of their, you know, hedging.

"The average hedge fund is a lousy bet," the Economist wrote.

It is a great deal to be a hedge-fund manager, however, because of the way you get paid. You typically skim at least 2 percent of your total assets under management, no matter how well or poorly you do, along with at least 20 percent of any "alpha" you stumble across. So, as New York's Kevin Roose points out, a manager like Dalio, with $83 billion under management, can make $1.7 billion "just for turning on the lights."

This is wealth redistribution, but in the wrong direction: From the wealthy to the far, far wealthier. Despite the general lameness of hedge funds, the median pay of the top hedge-fund managers jumped in 2012 to $350 million from $235 million in 2011, according to Alpha magazine.

And this is also why friends don't let friends invest in hedge funds: Market crashes and all, you'd have done far better in an index fund for the past decade.

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