Thursday, January 22, 2009

Hedge Fund Oxymoron?

In a report released on Wednesday, tracking firm Hedge Fund Research said investors pulled $155 billion from the secretive portfolios.

What separates hedge funds from other, better regulated funds and investment vehicles is that hedge funds are chartered to engage in short selling, buying and selling options and other devices designed to "minimize risk." The whole idea behind the concept of hedge funds is that they can weather any kind of market and make money in any environment.

So why did they take - on average - a 19% beat-down in 2008? It seems that the hedges were trimmed when they should have been sprouting new branches. While mutual funds lost an average of 38% last year, the hedge funds should have been in a position to identify the enormous risks in the market and "hedge" accordingly.

But maybe the term is oxymoronic. Maybe the average hedge fund manager isn't any smarter than the guy with glasses who handles your pension plan, and maybe, despite the tools available to them, the hedge fund managers were not any more aware of what the banks were going through in 2007 and 2008, and failed in their charge to ameliorate risk by shorting, buying puts or exiting losing positions in timely manners.

When this ugly chapter of economics is finally unwound by financial historians, it's likely to be revealed that the clandestine hedge fund community was one of the major contributors to the extreme volatility in markets during the final three months of 2008, fleeing financials just like the rest of the duped investors who thought the subprime crisis was "contained" - a la Ben Bernanke - as markets and profits disappeared like the vapid promises of "higher returns."

Greed, an emotion which knows no bounds, is what attracted the rich and not-so-famous to hedge funds in the first place, and it is the same greed (masked as fear of losing their cash hoard) that is fueling the exodus today. Had the hedge funds really been on the ball, they would have profited from the relative ignorance of the rest of the market. Unfortunately, hedge fund managers turned out to be not the "smartest guys in the room," but merely a little smarter than the average broker.

Investing is largely about managing risk, and while the hedgies purported to managed risk better than the average, their losses - and subsequent redemptions - proved their fallibility and the underlying investment risk dictum, "nobody is immune."

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