Via Felix Salmon, I just read an entertaining (but I think dubious) blog post from hedge fund blogger Veryan Allen taking on indexing pioneer Jack Bogle. Here’s a taste:

Is it really common sense to imply investment skill cannot exist and investors should not try to identify good fund managers? Not many would want to ride in a car driven by John Bogle. I guess he would just place a brick on the accelerator, remove the steering wheel, gaze at the rear view mirror and wait for the nice destination he anticipates. No need to worry about ongoing risks and obstacles in the path when paradise looms in the so-called long term….

I’m mostly with Bogle on this one. You can argue until you are blue in the face whether investment skill really exists. (Beyond a basic hurdle of competence, that is.) I’m not sure it does, but I’m not sure it doesn’t. But I’m downright certain that I can’t identify market-beating investment skill in advance. Not only is past performance no guarantee of future results (as they say in the fund ads), it probably hurts future results. When a fund manager gets hot he attracts a lot of new money he has to put to work in the market, which usually forces him to build a portfolio that looks more and more like the index. Either that or he quits to start a hedge fund. Buy an index fund and you don’t have to worry about any of that. You just own the whole stock market–and cheaply, too.

But that’s just the case for index funds vs. active mutual fund managers. What about indexers vs. hedge funds, those largely unregulated private investment vehicles that have become so popular among institutions and the super-wealthy?

Hedge funds are different. Buy a typical U.S. stock mutual fund, and you’ll basically get U.S. stocks’ returns, plus or minus luck, and maybe plus or minus a premium/discount for risk, and definitely minus expenses. A real hedge fund, on the other hand, is traveling far afield from the S&P 500. It may be shorting stocks, levering up, buying commodities, doing land deals, investing in private firms, making currency plays… you name it. So a hedge fund has a real shot at making money in falling stock market. (As well as a good shot at falling apart in a rising market, I should add.) If nothing else, they can provide diversification. And that’s not nothin’ at all.

Still, I doubt it’s much easier to identify outperforming hedge fund managers in advance than it is to identify next year’s winning mutual funds. And for most of us, it’s an academic question. You have to have A LOT of money to buy into a hedge fund, and I suspect you have to have bucketloads of gushers full of millions of A LOT of money to get into the best ones–especially if you don’t want to be gouged by middlemen. Some mutual funds are trying to approximate hedge strategies, and I’m intrigued by a few of them, but by their nature they’ll always lack some advantages that the hedgies enjoy. Most will be too big, for example, and they won’t be able to keep their investors from taking their money out for months or even years. (On the other hand, they are far cheaper.)

Some of the smartest pension and endowment managers have been using hedge funds as a basic ingredient of their long-term asset allocation. Are they having any luck identifying real talent? Who knows? But they are broadening their clients’ market exposure in a way that most individual investors cannot. Perhaps that’s one more reason to regret the sharp decline of traditional pensions in favor of 401(k)s. Many of us have been forced to take over the job of managing all of our retirement assets, but we’ll never have access to all the tools the pros can use.