“I like nonsense, it wakes up the brain cells. Fantasy is a necessary ingredient in living.” –Dr. Seuss

Fantasy may be a necessary ingredient in living, but in choosing investments it can be perilous.

The biggest fantasy in the world of investing is the Market Neutral strategy. Market Neutral is the fanciful idea that there is a certain class of funds which can be perfectly hedged from market risk, generating returns purely from alpha. They also promise significantly lower volatility and no correlation to traditional stock indices.

“Sounds great, I’m wiring the money now,” said many an institutional investor over the years.

And what have Market Neutral funds done for their investors over the past 15 years? In a word: nothing.

The HFRX Market Neutral Index has a total cumulative return of 3.0% over the past 15 years versus a 124% gain for the S&P 500.

The hedge fund true believers will argue that it’s not just about return. The Market Neutral Index had a -.01 monthly correlation with the S&P 500 over this period with only 3.6% annualized volatility and a maximum drawdown of 14.9%.

Surely you would want such an exposure in your portfolio, even if it returns nothing, they would say.

I could debate them on that point but as it turns out, I don’t have to. There was another asset class with a -.11 correlation to stocks over this period and 3.5% annualized volatility with a maximum drawdown of only 3.8%.

What is this magical asset class? Simple, boring bonds. The Barclays Aggregate Bond Index returned 107% over the past 15 years while providing the same low correlation and low volatility that Market Neutral funds crow about.

True, there are no fancy offices or colorful marketing books with bond index funds. There are no high pedigree managers or sumptuous steak dinners. And finally, there is no fantasy of being perfectly hedged.