Hedging the funds

I have just spent my first hour of writing time this morning researching Hedge Funds.  Why?  I have to ask myself.  Will I be able to invest in these non-regulated entities?  No chance, unless I win the lotto or some relative I never knew I had suddenly dies and leaves me millions.  Or maybe I’ll get in a car crash and sue for $$$,000,000.  Yeah, like I said, no chance.  On the other hand, maybe life is a sort of hedge fund, the way you live it that is. 

At Wikipedia we find this definition for hedge funds:

A hedge fund is a private investment fund that charges a performance fee and is typically open to only a limited range of qualified investors.

Highly qualified, I’d say since usually your initial investment is $250,000 or more.  And each fund can only have up to 100 investors, though there are some exceptions, I think.

As their name implies, hedge funds often seek to offset potential losses in the principal markets they invest in by hedging their investments using a variety of methods, most notably short selling. However, the term “hedge fund” has come in modern parlance to be applied to many funds that do not actually hedge their investments, and in particular to funds using short selling and other “hedging” methods to increase risk, and therefore return, rather than reduce it.

Here, you need to think of the recent surges in price for commodities, think of how large amounts of money invested in a specific future (okay I wouldn’t do the pork belly thing but it is one future) say rice.  Think about how much power a shrewd manager might have in moving these markets.

Hedge funds have acquired a reputation for secrecy.

Thanks to Bear Stearns and others, the pressure to pierce the vail of the funds has grown immensely. 

While there is no legal definition of “hedge fund” under U.S. securities laws and regulations, typically they include any investment fund that, because of an exemption from the types of regulation that otherwise apply to mutual funds, brokerage firms or investment advisors, can invest in more complex and riskier investments than a public fund might.

But how can you pierce what doesn’t exist.  Oh the funds exist, held in Barbados, the Cayman’s, and other off shore havens but that is all they are funds. 

 The assets under management of a hedge fund can run into many billions of dollars, and this will usually be multiplied by leverage. Their sway over markets, whether they succeed or fail, is therefore potentially substantial and there is a continuing debate over whether they should be more thoroughly regulated.

The managers usually form an LLC in order to direct the operation and handle the investments.  For this the standard income is something called 2 and 20.  2% for managing the fund and a 20% performance fee based on what the fund earns.  As you might guess, these fees may vary anywhere from 0 and 50 and inbetween.

I think the thing to understand about these hedge funds and their managers is that they are in it for the money for the most part and will seek to set up a fund for just about any purpose.  And though, I am sure there are “green”  hedges too, for the most part the fund comes first and the world second.  Which explains why this comment was made on dealbook:

1.

A flattening of the yield curve, if it sticks should be bad for value stocks (who typically grow via debt) and growth stocks. Is this a harbinger? Does this hedge fund know something the rest of us can’t see? Hard to believe it, especially with all the pressure on the $US. But on the other hand, all the [bad] news on the dollar has been…. well, bad. So the other question is: “Are we at a $US inflection point?” Again, it’s hard to believe, with [pro forma] M3 growing at a close to all time high annual rate of 20% (kinda explains why they don’t report it anymore, huh?). From a supply and demand perspective, supply is flooding the world (we’re awash in dollars), so any relief has to come from increasing demand. I’m not an economist, but typically fear and greed will trigger demand for dollars — a big scary event, like a new terror wave, or some kind of economic renaissance in the US which will want to make capital come here. Why would anyone place a bet on those 2 items? Conceivably, a recession would be good for the dollar, but it would have to be pretty steep. Yes, that’s it. This hedge fund is betting on a recession, one steeper than the conventional wisdom. That would stem the flood of dollars leaking out into the world economy. For bond players, time to go long if you believe it.

Dave

— Posted by david russell

Any questions?

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1 Comment »

  1. They are definitely in it for the money. I think the popularity of hedge funds is really going to take off in about 18 months once this current recession is past us. Hedge funds have been outperforming many long only managers and benchmarks for a while now and as they continue to stay within positive territory or lose less then most passive “safe” investments I think they will pick up some new fans along the way.

    Nice post.

    – Richard

    Richard Wilson
    Hedge Fund Consulting Blog
    http://richard-wilson.blogspot.com

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