Friday, August 04, 2006

Another Hedge Fund Casualty

Today comes word that a superbly managed hedge fund, run by a highly qualified person and with the homey and reassuring name of MotherRock L.P., has shut down after sustaining huge losses in the natural gas market. Now, this kind of thing happens so often that it is barely worth mentioning, but I thought I'd mention it anyway.

Why do such superb funds go belly up so very often? The reason is simple, dear friends. It is because hedge funds are designed with failure in mind.

In theory -- as indicated by the "hedge" in hedge funds -- these funds are supposed to hedge against losing a ton of money and going out of business. Some funds actually are hedged, but they are in the minority. So funds take large directional bets, the bets go sour, and they go out of business.

Why do they go out of business instead of staying on, and battling back? That's because most hedge funds are structured so that their managed can't pull down their massive incentive fees (commonly 20% of annual profits) until they make up previous losses. I don't know if MotherRock was structured this way, but that's a good possibility. These "high water mark" provisions are designed to protect investors, but in fact they do the opposite by giving managers an incentive to shut down their funds.

Anyway, I'm only guessing if that was the reason MotherRock shut down, and in any event is that it is not important. The important thing is that MotherRock investors got a really sweet, sincere apology from the boss man, former New York Mercantile Exchange President J. Robert "Bo" Collins. According to the Wall Street Journal, Collins said: "Let me say upfront that I regret MotherRock's terrible performance and its impact on your investments."

Wasn't that awfully decent of him! I mean, what more can investors in hedge funds expect anyway? It's like that line from A Thousand Clowns: "That's the most you should expect from life--a nice apology for all the things you won't get."

© 2006 Gary Weiss. All rights reserved.


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