PAST PERFORMANCE is no guarantee of future results—and that’s especially true once an investment goes from backwater to broad acceptance. Take real-estate investment trusts. Over the past 15 years, they have been embraced by investors, leading to great returns as folks loaded up on REITs. But that widespread acceptance was a onetime event—and returns from here will likely be more modest, especially with equity REITs yielding just 3.4%, versus almost 9% at year-end 1999.
Or consider inflation-indexed Treasury bonds. When they were first sold in 1997, the yield above inflation was a handsome 3.45 percentage points. But that yield fell as the bonds gained broad acceptance, and today the 10-year note yields a slim 0.5% above inflation. Emerging market bonds and commodities tell the same story: The early adopters enjoyed great performance, but results from here will probably be far less stellar.
Hedge funds are an investment vehicle, not a market sector. Still, I suspect a similar phenomenon is at work. There are now so many hedge-fund managers hunting for an investment advantage that returns will almost inevitably be lower—and lower still once you figure in the hefty costs that the funds charge.
That raises an intriguing question: Are there investments that haven’t yet entered the mainstream and where early adopters could reap outsized returns? One obvious possibility: so-called frontier markets like Kenya, Kuwait, Nigeria and Pakistan. But this is dicey stuff. Even if you were going to invest—and I haven’t—you’d probably want to allocate no more than 2% or 3% of your stock portfolio.