Hedge Your Bets

In the past decade or so, one investment option has gained prominence in the world of ultra high-end investments. They are called hedge funds, and we’re going to find out a little more about them today, not so that you can invest in them, because you’re most likely not wealthy enough to do so, but just so that you’ll understand what they are when the topic comes up at your next gathering to watch “Ugly Betty.”

Hedge funds are one of those investment vehicles people like to pretend they understand, but I’m here to tell you this is usually not the case. They are a mystery to many people, so when someone is talking with profound understanding about anything having to do with hedge funds, regard him or her with some healthy skepticism.
Yes, a hedge fund is a vehicle for investing. But a hedge fund is different than most other investment options in certain respects.

A hedge fund is only open to a small number of investors — very wealthy individuals or corporations, retirement plans, etc. Hedge funds were created to provide tremendous profits for those who have millions to invest.

Therefore, there are not the usual constraints imposed on a hedge fund that are imposed on a mutual fund. Hedge funds do not have to be registered with the Securities & Exchange Commission the way mutual funds do.

Hedge funds originated back in the 50s, but it wasn’t until the late 60s when they came on the radar screen of many wealthy investors. It was an opportunity to follow an investment superhero into the heavenlies of super wealthy investing returns. The people who formed and operated the early hedge funds took advantage of their knowledge of commodities, stocks, bonds, real estate, you name it. If it could become an investment and make someone money, it became part of a hedge fund. And because there were no government restraints to speak of, as we said, there was — and remains so — very little control.

What a hedge fund can offer an investor is the opportunity to make much higher returns than one would find in the mutual fund or individual stock world. Because hedge funds deal with such large amounts of money, their managers will not take people whose net worth does not equal seven figures. (For “seven figures” read: “more than a million dollars.”)

In the 70s and 80s it was very chic to say that your hedge fund manager had called you to tell you about a prime investment he was putting your money into. This made for good cocktail party bragging, but the reality is more likely that a hedge fund manager didn’t bother to tell his clients where the investment money was going. He was the Lone Ranger, doing his own thing, accountable to no one. Of course, if the hedge fund did badly, the investors could try to get their principle back out, never mind the profits. But if a hedge fund did do badly, there was not much recourse because the government was hands off.

Do you see the risk involved?

Now we come to the 21st century, where investment people have continued to create new ways to invest money. One of those ways is a mutual fund made up of hedge funds! Another way is to buy stock in a hedge fund itself that has gone public. One such, Fortress Investment Group, LLC (FIG), soared when it was first offered as a stock in and of itself but has since settled back down. Many predict that there will be more hedge fund IPOs in the months and years to come. So you don’t have to put millions of your own money in a hedge fund but can buy shares of stock instead that will benefit you if the hedge fund does well. Of course, if the hedge fund tanks, as they often do because of a single bad investment, your stock value will tank as well.

Today, there are more than 9,000 hedge funds, more than 300 of which manage one billion dollars or more. Many of the best brokerage experts are jumping ship from the traditional brokerage firms to go the hedge fund route. After all, there is a promise that a good, successful hedge fund manager can make millions for himself while also making millions for his clients. The lure of the hedge fund is sometimes too strong to resist.

It will be interesting to see what happens to this investment vehicle in years to come. Will the investing public raise a hue and cry and have the SEC step in with more regulation? Will the bad hedge funds — those that fail to achieve great results for their clients — outnumber the good ones so eventually people turn back to more traditional investments for higher security and less risk?

It remains to be seen, but it will be fun to watch.

… From the sidelines.


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