Hedge Funds And Risk
Hedge funds now exist
in many forms.
Originally hedge funds
started as a way to control market risk. Most speculators
agree it is almost impossible to guess where
the markets will go tomorrow.
would probably agree -- there are a million ways
to make money in the markets - all of them short lived
and hard to find.
Once upon a time money managers
decided to hedge their risks - buy companies they liked
- and fade (sell short) companies they didn't. This
theoretically allowed them to make a profit and avoid
loss regardless of market direction.
Hedge funds were touted as a wealth
defense. Very few true hedge funds were created and
survived. Hedge funds started drifting toward bias hedeges;
a bias toward one side of the market or a bias hedge
by asset class.
Investment managers discovered however
they could structure a hedge fund around regulation.
Huge incentive rewards for investment management then
assured success of the name hedge fund.
There are now thousands of hedge funds
- almost all of them high risk. Statistics on success
have a decided survivability bias, even stronger than
the regulated mutual funds.
If you start a year with 3000 hedge
funds taking huge leveraged risks, some will prosper,
It is almost impossible to tell which ones at the start
of the year.
Five hundred hedge funds may win big
and start attracting hot money. One thousand hedge funds
might do horribly and close or merge. The 1500 hedge
funds in the middle languish and wait for next year.
Of course when money managers look
at the income made by the top 500 hedge fund managers
- you will have more than 1000 new hedge funds for the
survivability bias looks at the above
information and says we have more hedge funds than last
year - and the older funds have done fantastic. The
huge overall gain is largely due to the losing hedge
funds disappearing or quietly merging themselves into
a "successful" hedge fund.
Lets look at the top 500 hedge funds
in the above example.
Next year assume 100 have a great
year, 100 are so bad they have to close or merge, the
other 300 can still brag on their "results since
inception." The top 100 managers paychecks and
egos are now huge. Continue and after 5 years you will
have a few wealthy hedge fund managers called "superstars
You could do the same. Maybe that's
how Hillary made a hundred thousand in the commodities
market and only "invested" once. The broker
may have had two opposite future accounts opened and
leveraged them to the hilt. One account went up $100,000.00
while the other account went down a similar amount.
Surprise - Hillary had the one that "earned"
The next view of hedge funds is even
less charitable. The first notice of this type of scam
I am aware of is in a book recommended by almost every
top investor, advisory, or speculator - Reminiscences
of a Stock Operator.
The latest version of the scam will
appear in tomorrow's email.
The way con artists can do the same
thing today is to send out 200,000 emails telling about
their "new" program. 100k emails will recommend
going long in Soybeans and 100k emails will recommend
Half of the recommendations will have
big gains and receive a new email - half recommending
going long in pork bellies, half of the emails recommending
short. After two wins money will start to come in for
"investment" in the program.
Repeat to the "winners" and
the cons are an expert with a great track record according
to the "lucky recipients of the offer." Rinse
It's a bit like being an
economist: if you can't guess right - guess often.
Today almost all hedge funds share
one characteristic - high unhedged leverage
- and great risk. Those that blow up will not be around
to taint next years graphs of hedge fund returns.
My opinion is derivatives will probably
cease to exist in their present form after they are
blamed for the next depression. In the interim they
are frequently tools of excess leverage that are hidden
behind the doors of many huge banks and other institutions.
These banks are counter-parties to
largely unregulated hedge funds, government agencies,
and corporate finance departments trading poorly understood
and dangerous financial instruments.
This derivative balloon will not end
Those that claim nothing has gone wrong
since LTCM are like the fellow that jumped off a fifty
story building. As the jumper passed each floor folks
could hear him saying; "so far so good - so far
Consider the above before you invest
in a hedge fund.
The graph a hedge fund shows you is
of them as a small percentage survivor, the past is
definitely no assurance of next years results. Be warned
-an "unforeseen catalyst" may cause devastating
Heck - if the devestaing financial
catalyst would have been foreseen the hedge funds would
have made money on it.
Bad things will continue to surprise
in the future.
Here is a repeat of an important speculation
rule that greatly applies to investing in hedge funds:
is not linear.
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