BrettArends

Ever since the financial crisis broke in 2008, investors have been looking for a magic bullet. They want returns without risk, investment without turmoil, profits without fear.

One of the options is mutual funds that look or act like hedge funds. They often have labels such as absolute return, total return or market neutral. In recent years, a whole wave of these has hit the market. Lipper lists about 440 funds in hedge fund-type categories. Only one in four has been around for five years.

More From Brett Arends

Are they any good? More important: Is the concept any good?

You can see the appeal to many shell-shocked investors. After all, hedge funds — those secretive and exclusive funds open to the rich and big institutional investors — are supposed to have all sorts of tricks up their sleeves. They can bet against overpriced stocks, bonds and other assets; hold cash; use derivatives; switch between asset classes. At a time of perpetual turmoil across the markets, this has to be a good thing, right?

Alas, the answer is, Well, yes, sort of. Sometimes.

Travel to the heart of the hedge fund world: Greenwich, Conn. a picturesque town on the New England coast about 40 minutes from New York. Walk through downtown, and among the upscale restaurants and chichi boutiques you’ll see something surprising: boarded-up shops. When I was there recently, I counted 16 cases of retail space for rent and long lease available in six blocks.

The shine has come off the hedge fund industry. The boom days of the midzeros have long gone. In two days in Greenwich, I saw no Ferraris at all and only one Porsche — and it needed a wash.

This should be a golden age for hedge funds. From Lehman Brothers to Greece, we have never seen so much turbulence as in the past few years. But the results aren’t what you’d expect. The median hedge fund was actually down in 2011, and this year is little better. Financial research firm TrimTabs says the industry is suffering net redemptions. Many marginal funds have vanished. Well-heeled investors have been turning more skeptical of the hype.

When the stock market went up a dollar, our hedge funds went up 40 cents; when the stock market went down a dollar, our hedge funds went down 60 cents, recalls Stan Mavromates, investment manager of the $50 billion Massachusetts state pension fund. Funds promised absolute returns, he says, but when 2008 came, we didn’t do as well as we thought we would. The losses wiped out all the gains of the preceding five years and then some. We thought, ‘What are we getting in value out of these funds?’

There are successful hedge funds out there as well. There is research to suggest the best ones really can produce higher returns, lower risk, or both. The trouble is that there are very few. Finding them in advance is a challenge. And they are like Groucho Marx’s ideal club: The best funds often don’t want your money.

When you are a hedge fund investor, you want to invest in the top 1 or 2 percent, says Brendan O’Brien at Gold Coast Wealth Management. These guys really do outperform the market across five or 10 or 15 years.

The numbers tell a story of how rare that can be. Industry research firm eVestment Alliance has one of the largest performance databases. It tracks thousands of funds. In the five years to the end of 2011, it says, the median hedge fund posted an overall gain of 23 percent. Over 10 years the figure was 104 percent.

Do you think that’s good? Think again. Most funds dropped off the radar along the way. They closed, or they just stopped reporting figures because they were doing so badly. Over just the past five years, says eVestment, two-thirds of the funds dropped out of its database.

Meanwhile, compare these returns with a benchmark portfolio that even Grandma could afford: 60 percent Vanguard Global Equity, 20 percent Vanguard Long Term Treasury and 20 percent Vanguard Treasury inflation-protected securities, rebalanced quarterly.

That portfolio gained 15 percent in the five years through 2011. It beat nearly half of the hedge funds that survived in the eVestment database. And over 10 years, that simple three-fund portfolio gained 119 percent: In other words, it even beat the median hedge fund among the precious few that lasted the distance — all, of course, while charging investors a lot less.

So what’s behind this paradoxical underperformance? Some of the problems are exclusive to investors in big-money hedge funds, such as the very high fees many of them charge, the perverse incentives that can encourage foolish risks and, in some cases, unregulated chicanery.

Yet the ordinary investor in the hedge funds’ cut-price mutual fund cousins has to overcome other problems. One is that few mutual funds will attract the brilliant minds you can find in Greenwich. Another is that mutual funds make their money from being big, not from being best, so fund companies must do what sells. That generally means chasing performance, and running with the herd.

Hedge fund managers — and their Main Street cousins — are fond of using jargon to spice up what they do, from alpha to beta to proprietary algorithms. It’s mostly a snow job. Anything based entirely on mathematical models is based on a fundamental flaw — the idea that past performance is a guide to the future. It’s an assumption constantly rebutted by history.

Meanwhile, any fund is only as good as its manager. Investors such as Charles de Vaulx at IVA Worldwide (now closed to investors), Stephen Romick at FPA Crescent and Warren Buffett at Berkshire Hathaway have managed to outperform markets over the stretch without resorting to jargon at all. The active managers I know and respect most are individual stock pickers.

The long and short of the hedge fund industry is that there is, of course, no magic bullet at all.