# How Do Hedge Funds Try to Beat the Market? > Leverage, short selling, factor and macro bets, and tight risk budgets. Here is how each one works, what the record against the S&P 500 looks like, and which ideas individual investors can actually use. Source: https://www.exent.ai/resources/how-hedge-funds-beat-the-market · Reviewed by David, Senior Analyst, Exent · Published Nov 5, 2026 · Updated Nov 5, 2026 ## Key takeaways - They combine leverage, short selling, factor and macro bets and strict risk budgets. Most aim for steady returns with low correlation to stocks, and as a group they often trail the S&P 500: in 2025 the HFRI composite rose 12.6% vs 17.7% for SPY. - In Warren Buffett’s ten-year bet (2008–2017), an S&P 500 index fund returned 8.5% a year; the five hedge fund-of-funds portfolios returned between 0.3% and 6.5% a year. - Beating the index is often not the goal. Many strategies try to make money when stocks fall, which costs return in bull markets. - The most useful ideas for individual investors are the risk tools: sizing positions by risk, knowing your net exposure and watching correlations. ## How do hedge funds try to beat the market? Hedge funds use tools most mutual funds avoid. The [SEC’s investor bulletin on hedge funds](https://www.sec.gov/files/ib_hedgefunds.pdf) lists leverage (borrowing to increase exposure, and risk), short selling and other speculative practices. Each strategy mixes them differently: | Strategy | How it tries to make money | Main risk | | --- | --- | --- | | Long/short equity | Buy stocks expected to do well, short stocks expected to lag; profit from the spread | Both sides can go wrong at once, as in a short squeeze | | Global macro | Bets on rates, currencies, commodities and indexes based on economic views | Large positions on a few calls | | Managed futures (trend following) | Follow price trends up or down across futures markets | Whipsaws in markets without clear trends | | Event-driven | Trade mergers, spin-offs, bankruptcies and other corporate events | A deal breaks or a restructuring fails | | Relative value / arbitrage | Exploit small price gaps between related securities, usually with leverage | Leverage turns small losses into big ones | | Factor investing | Tilt toward traits like value, momentum, quality or low volatility | Factors can lag for years | ## What are leverage, shorting and factor bets? - **Leverage** means controlling more than your capital, through borrowing or derivatives. It magnifies gains and losses alike. A small edge, levered several times, can become a meaningful return; a small mistake can become a large loss. - **Short selling** means selling a borrowed security and buying it back later, profiting if the price falls. Losses on a short have no ceiling, because a price can keep rising. - **Factor bets** tilt a portfolio toward characteristics that have historically been rewarded, such as value or momentum. See factor investing. These tilts are now cheap to buy through ETFs, which is one reason they no longer justify hedge fund fees on their own. - **Gross and net exposure** describe how much is invested long and short. A fund that is 150% long and 100% short has 200% gross exposure but only 50% net market exposure. More in gross vs net exposure. ## Do hedge funds actually beat the S&P 500? As a group, usually not in rising markets, and the evidence over long stretches is unflattering. Two well-documented comparisons: | Comparison | Hedge funds | S&P 500 | | --- | --- | --- | | 2025 calendar year (HFR; SPY from Exent data) | HFRI Fund Weighted Composite +12.6%; Equity Hedge +17.3% | SPY +17.7% | | Buffett’s bet, 2008–2017 (Berkshire 2017 letter) | Five funds-of-funds: 0.3% to 6.5% a year | Index fund: 8.5% a year (+125.8%) | HFR reported that 2025 was the composite’s strongest year since 2009, per [WealthBriefing’s coverage of the HFR release](https://www.wealthbriefing.com/html/article.php/hedge-funds-log-strongest-calendar-year-returns-since-2009-), and it still trailed the S&P 500. In the bet described in [Berkshire Hathaway’s 2017 shareholder letter](https://www.berkshirehathaway.com/letters/2017ltr.pdf), every one of the five hedge fund portfolios trailed a low-cost index fund over a full decade, after fees. Fees are a large part of the story. Hedge funds typically charge a management fee on assets plus a performance fee on profits, and funds-of-funds add a second layer. A strategy has to earn a lot before costs to keep pace with the index after them. The same arithmetic explains why most active mutual funds trail too: see can you beat the market after fees and taxes? ## If they trail the index, why do investors use hedge funds? Because many are not trying to beat the S&P 500 in a bull market. They are trying to earn returns that do not depend on it, and to lose less, or even gain, when stocks fall. A fund that returns less than the index but zigs when it zags can improve a whole portfolio’s return per unit of risk. A public example is a managed-futures ETF that replicates trend-following hedge funds. In Exent’s data (to Sep 30, 2026), DBMF behaved like this: | Total return, to Sep 30, 2026 | DBMF (managed futures ETF) | S&P 500 (SPY) | | --- | --- | --- | | 2022 return | +21.6% | −18.2% | | 2023 return | −8.9% | +26.2% | | 5-year annual return | 9.9% | 13.6% | | 5-year volatility | 12.2% | 15.7% | | 5-year max drawdown | 17.3% | 23.9% | | Correlation with SPY (60 months) | −0.26 | 1.00 | It lagged in the long run and in strong stock years, and it gained in 2022 when stocks and bonds fell together. That is the trade-off: diversification in bad years, paid for with lower returns in good ones. See what actually diversifies a portfolio. Past behavior is not a guarantee it will repeat. ## What is a risk budget, and why do hedge funds use one? A risk budget caps how much any one position, sector or idea can contribute to total portfolio risk. Professional managers size positions by expected volatility and correlation, not by conviction alone, and set drawdown limits that force them to cut risk after losses. The aim is to survive long enough for an edge to show up. More in risk budget and position sizing. ## What can individual investors learn from hedge funds? Hedge funds are generally open only to accredited investors, institutions and wealthy individuals, according to the SEC bulletin, and they come with fewer disclosure requirements and limited liquidity. The transferable part is the risk discipline, which costs nothing: - Know your real market exposure: a portfolio of high-beta stocks can carry more market risk than its dollar value suggests. - Size positions by how much risk they add, not only by how much you like the idea. - Group holdings that move together and treat each group as one bet. - Decide in advance what drawdown you would act on, and what you would do. - Judge results by return per unit of risk against a fair benchmark, not by return alone. None of these steps needs leverage, short selling or a hedge fund’s fees. They aim at a better return for the risk taken, not at beating the index every year, which most professionals fail to do. For the broader evidence, see the [beat the market](https://www.exent.ai/beat-the-market) guide. ## How to apply these checks with Exent 1. Upload a screenshot of your holdings (or a CSV, Excel, PDF or Google Sheet); no brokerage login. 2. Exent groups holdings into correlation clusters, replays crashes from 2008 to 2025 and shows Sharpe, Sortino and Calmar ratios against a risk‑matched benchmark. 3. The efficient frontier and the what‑if simulator show whether a different mix would have earned more return for the same risk; Exent does not run leverage or short positions. Exent is our product: [Exent Market intel](https://www.exent.ai/intel) ## Frequently asked questions ### Do hedge funds beat the S&P 500? As a group, usually not in rising markets. In 2025 the HFRI Fund Weighted Composite gained 12.6% while SPY returned 17.7%, and in Warren Buffett’s 2008–2017 bet five hedge fund portfolios all trailed an S&P 500 index fund. ### What strategies do hedge funds use? The main families are long/short equity, global macro, managed futures, event-driven, relative value and factor strategies. Most use some mix of leverage, short selling and derivatives. ### Why do hedge funds underperform the market? High fees, hedges that cost money in rising markets, and strategies designed to lower risk rather than maximize return. Many aim for low correlation with stocks, which means lagging in strong bull markets. ### Can regular investors invest like a hedge fund? Most hedge funds are limited to accredited investors. Some strategies, such as managed futures and factor tilts, are available through ETFs, and the risk tools hedge funds use, like position sizing and exposure tracking, can be applied to any portfolio. ### What is the difference between a hedge fund and a mutual fund? Hedge funds can use leverage, short selling and concentrated bets, are generally limited to accredited investors and face lighter disclosure rules. Mutual funds are open to everyone, are more tightly regulated and mostly hold long positions. --- Educational content, not investment advice. Past performance does not guarantee future results.