Its one of those rare moments of humility on Wall Street, a placed where indicted but never convicted is a badge of honor. A hedge fund chief who lost all of his clients money told them he was sorry.

Owen Li, founder of Canarsie Capital, wrote to his clients to say he had run their accounts down from $100 million less than a year ago to just $200,000. Reportedly. he got into a hole and took on a string of high-risk bests to try to save his firm.

It didnt work out. My only hope is that you understand that I acted in an attempt — however misguided — to generate higher returns for the fund and its investors. But even so, I acted overzealously, causing you devastating losses for which there is no excuse, he wrote.

Heres the thing, though. Hedge funds are not supposed to be running extremely high-risk strategies. Theyre supposed to hedge risk by investing in ways that protect wealthy investors from dramatic losses.

You might not get an amazing return from a hedge fund (and its interesting that people think thats the goal) but instead get a reasonable return with minimal risk of big losses. Thats why rich people use them.

A hedge fund, if correctly operated, is in fact just one slice of a larger asset pie, one which includes stocks, bonds, real estate and commodities. There has been a lot of research over decades to support the idea that again, properly run, a limited hedge fund allocation can lower overall volatility in a very large portfolio.

Thats why universities and endowments use them. Of course, as with any hot investing trend, demand outstrips supply. CalPERS, the big California state pension fund, famously gave up on hedge funds in 2013, precisely because their high fees were unjustifiable in the face of shoddy performance.

Hedge fund alternative

For ordinary retirement investors, the risk is far, far too high and the hedge effect can be purchased much more cheaply in other ways. By simply owning a well-designed, well-allocated portfolio of index funds  you get a lot of risk management at a very low price.

Rebalancing with discipline allows you to book gains as they occur, selling high and buying low in a timely fashion. All thats left is to make sure that your exposure to higher volatility asset classes — chiefly stocks — is slowly lowered over time as you near retirement.

Sometimes, you dont get what you pay for in an actively managed fund, and sometimes you get something you never bargained for — high risk and poor oversight from the managers themselves .

You may like these other MarketRiders articles: