Wednesday, March 08, 2006

The Stupidity of Hedge Fund Investing

Some news out of Atlanta recently (see this AP story) underlines a point to which I devote several chapters in Wall Street Versus America -- investing in a hedge fund, including one of the ubiquitous funds of hedge funds, is one of the dumbest things you can do with your money.

The Atlanta news highlights just one of the many reasons to steer clear of these overhyped doggies -- the chance that the fund manager might simply walk away with your money. Quoting an SEC and private lawsuit against fund manager International Management Associates, which is contesting the charges, the AP reported as follows:

[A hedge fund manager] and his company are accused of collecting between $115 million and $185 million from at least 500 investors since 1997 and misleading some of them -- through false statements and documents -- to believe the value of those investments was increasing.
"Certainly over the past year and earlier, the amount of money that was supposed to be in the respective funds was, in fact, not there," SEC lead counsel Bill Hicks said.

This same thing has happened, in various guises, again and again and again.

Sure, the vast majority of hedge fund managers are honest, upright, upstanding citizens. It's not their fault that some crumb bums are entering the business and that hedge funds are structurally prone to the kind of thievery that allegedly occurred here. In fact, you can argue that hedge fund investors -- in this instance a slew of NFL football players -- have only themselves to blame for being naive enough to buy into a hedge fund in the first place.

Yet they (or, more precisely, their managers) do so. Why? I devote several chapters to hedge fund fallacies in my book, and here is an oversimplified breakdown:

* Myth. Hedge funds are a subject of a massive media-fed mythology. A large part of this mythology involves "Super Investors" who aren't so super.
* Data. The available data, particularly over the long-term, just isn't very good.
* Opacity. Hedge funds aren't obliged to say a thing to anybody, with the exception of some new SEC registration requirements that aren't going to do much good.

Now, all this is just the problems that hedge funds pose from an investor standpoint. They also pose systemic issues, mainly involving derivatives and leverage, that have not been addressed by regulators. By the way, that's another reason to get annoyed with the "naked shorting" conspiracy cultists -- they want regulators to address a non-problem posed by hedge funds, diverting attention from the real systemic issues.

Fortunately, only a small minority of investors can buy into hedge funds. However, the rules are so riddled with loopholes that more investors than ever can invest in them. The rest of us are left with a a form of managed investment that is only slightly less dumb -- an actively managed mutual fund.


Wall Street Versus America will be published by Penguin USA on April 6.
Click here for its listing and here for more information on the book, from my web site.


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