Hedge funds are investments that are expensive, but also guaranteed to make you rich, if you are a hedge fund manager. Why do people continue pouring money into hedge funds?

Gregory Zuckerman noted in the Wall Street Journal this week that hedge fund exhibit an extremely odd property: they are ripoffs, yet people keep giving them more and more and more money. Specifically, over the past six years, hedge funds as a class have had lower returns than extremely basic index fund portfolios, despite charging many times more than those simpler investments. During that same time, people have invested another $1 trillion + into hedge funds.

This doesn't make sense based upon the following arcane but well-established principle of finance: "math."

Why is it that big institutions and very rich people continue paying lots of money to hedge fund managers to give them lower returns than they could get with very cheap and simple index fund portfolios? There are many theories. Here is one from Barry Ritholtz: "The best answer I can come up with is that investors are irrational." He is correct.

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