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October 31, 2006

22 Reasons Why Hedge Funds Stink For the Average Investor

Making positive or negative headlines, hedge funds are doing it with a splash, creating mighty waves rather than tiny ripples. On one hand you have success stories like George Soros and his macro fund, Soros Fund Management, who earned not only a billion dollars with his shrewd currency speculation, but also the envy of all and sundry in the industry. On the other end of the spectrum are the colossal disasters like Long-Term Capital Management and Amaranth Advisors LLC that were, and still are, the talk of the town for the massive losses they suffered because of poor investment calls.Soros

No matter which way its fortunes swing, the $1.34 trillion industry is continuing to grow and flourish. Investors are being baited with promises of profound profits, even as the funds themselves shroud their activities in a cloak of secrecy. For those who find themselves oscillating between “should I” and “shouldn’t I” on the investment scale, here’s a list of 22 reasons why hedge funds are not the average investor’s cup of tea!

1. Risks – not to life and limb but to cash and currency: Hedge funds are prone to both investment and operational risks. The choice of strategy, the money earmarked for each plan, and the instruments chosen for investment – all contribute to investment risk. Operational risk rests with the fund’s policies, business methods, and accounting and reporting methods.

2. Possible strategic upheaval: Hedge funds use irregular trading strategies like derivatives, options, and short selling in their bid to generate absolute returns (positive returns irrespective of a bull or bear market). As a result, volatility is very high. Returns do not follow the natural normal distribution; they are skewed in what is called a fat-tail distribution, which in plain English means that there are small probabilities of large losses.

3. Promises made but hardly kept: Hedge funds promise spectacular returns on your investment. The catch here is that if something is too good to be true, it generally is. The returns are not as projected most of the time.

4. Long arm of the law not long enough: Hedge funds are not required to be registered with any regulatory body such as the U.S. Securities and Exchange Commission (SEC) unless they have over 99 investors. The absence of regulations and the uncertainty of offshore investments make hedge funds a doubly dangerous investment vehicle.


5. Special keys needed to enter portals: Investors have to be “accredited”, which means that they meet certain minimum requirements – a net worth of $1 million, or an individual annual income of $200,000, or a joint annual income of $300,000 (two years minimum), or being a general partner, executive officer, or director for the issuer of an offered security.

6. No see-through walls here: The lack of transparency is one of the biggest disadvantages of hedge funds. Transactions, strategies, and operational tactics are generally kept under wraps for fear of a competitor gaining a financial edge. This works out adversely for the investor who is unable to see how his/her funds are being used to generate returns.

7. Hedge funds - haven for crooks: Fraud, scandals, allegations of insider trading, meltdowns – these are run-of-the-mill occurrences for hedge funds. The lack of sufficient regulations facilitates moral and financial wrongdoings, which, at the end of the day, are not advertisements for the industry.

8. You’re putting all your eggs in one basket: The success or downfall of a hedge fund is largely dependent on the manager’s financial acumen and savvy in picking the right investments. Most investors pick hedge funds based on the manager’s reputation in the financial markets. If he/she retires, steps down, dies, or is otherwise indisposed to carry out his/her duties, investors may find themselves in a quandary. Managers who stick to a single strategy even when it is not right for present market conditions also pose risks for investors.

9. Managers skimming the cream: Managers of hedge funds have their cake and eat it too. Besides taking 1 to 2 percent of assets annually, they retain 20 percent of returns, both realized and unrealized. This proves to be very costly for investors. The 20 percent is usually allowed only if returns exceed a certain amount called the high-water mark. Failure to meet this minimum requirement may see managers closing up shop, only to open it elsewhere with a new base high-water mark. Investors end up holding the losses incurred.

10. Liquidity and its lack thereof: If you are looking to redeem your investment midway, bear in mind that hedge funds manage assets that are largely illiquid. The problem of liquidity is seen both on the assets – the quick liquidation of assets translates into huge transaction costs – and on the liabilities side – possible investor redemptions and high leverage - of the balance sheet.

11. There’s no passing the buck: Unlike mutual funds and stocks, there are no secondary markets for hedge funds. You cannot transfer or sell your interests in a fund.

12. Taxing troubles: Hedge fund transactions are often complicated and give rise to tricky income and capital gains tax issues. The choice of certain strategies may result in tax information being sent out late to investors, thus causing them tax problems.

13. Can’t get out while the going is good: Ok, your fund is doing spectacularly well, and you wish to gather up your windfall and leave. More often than not, this is not a possible option because of what’s call the lock-up period, where investors are not allowed redemption options for a minimum period. A typical lock-up period is between one and three years. Closure or failure of the fund brings more woes – you may get only a part of your investment back.

Firefly 14. Hedge funds - the fireflies of the financial family: Long term investments are not feasible when the average life of a hedge fund is only three years. In spite of all the new funds mushrooming over the world, an estimated 10 percent of funds wind up operations every year.

15. Manager’s pet, it better be you: Some investors find favor over others through the use of side letters. They are offered more transparency of the fund’s actions, lower fees, and shorter lock-up periods. This could end up affecting the positions of other investors.

16. Too crowded for comfort: With the implosive growth of the industry, there are more managers trying to jump on the strategy bandwagon that is currently in vogue. This could lead to returns diminishing over a period of time.

17. Hypothetical (hyped up?) performance: Hedge funds generally tend to state pro forma performance, as a result of which reported performance is considerably different from actual trading results. At times, excellent performance is based on one good trade, which may be the result of a stroke of luck rather than judicious decision-making.

18. To each his own does not work here: A conflict of interest between investors and the manager can cause strategies being changed mid-stream, especially if the investor has sufficient clout and knows the right strings to pull. Strategies that have a high probability of success in the long run may be abandoned because of investors railroading managers when there is a performance reversal.

19. History may not repeat itself: Past performance cannot be used as an indicator of a hedge fund’s current or future performance. Stellar returns are not a guarantee just because a fund has done well so far.

20. Molehills may be called mountains: Hedge funds tend to overstate their net assets under management to hype up performance details. Transaction values on trades conducted during the course of a month may be used instead of end-of-the-month numbers.

21. Reading between investment lines is an art: Accredited investors who earn pots of money are not necessarily shrewd and canny when it comes to assessing the right investment portfolios. Which means that being “accredited” is not protection enough to invest in hedge funds.

22. Fractional gains, whole losses: Managers and general partners share in the profits when a hedge fund generates large returns. But when the tide turns and the losses start pouring in, the fund is taken out of circulation, and a new one germinates, most often in an overseas location. The ultimate losers are the hapless investors.

The reasons provided above are just a nutshell view and do not detail all that’s wrong with the hedge fund industry, but they should suffice to deter those who are averse to high risk and volatility from putting their trust and money into such investment vehicles. For those who decide to go ahead in spite of all the pitfalls, they would be wise to follow experienced counsel and get satisfactory answers to certain questions before getting their toes wet.

October 29, 2006

More Calls for Regulation

-- By Pushpa Sathish, Staff Writer

Following the example set by Senate Finance Committee Chairman Charles Grassley, Treasury Secretary Henry Paulson has called for more protection for hedge fund investors. He stressed on the need to check if funds are transparent in their operations and if they have enough liquidity, especially in the light of what happened at Amaranth Advisors LLC. Bloomberg reports:

The Treasury department is leading a task force that's examining the impact of hedge funds on financial markets. That inquiry also involves the Securities and Exchange Commission, the Federal Reserve and the Commodity Futures Trading Commission.

What’s Hot, What’s Not!

-- By Pushpa Sathish, Staff Writer

Executives in the hedge fund industry are forecasting a good performance year ahead for those funds that deal in merger and acquisition arbitrage. These funds take advantage of impending mergers to trade stocks of the concerned companies, either before the news is made public or after the announcement is made.

Another category that is expected to do well is the global macro fund that speculates on bond, equity and currency markets, and on long/short funds equity funds. The best performers so far are the convertible arbitrage funds that trade in the components of convertible bonds that can be converted into a company’s stock.

Convertible arbitrage funds
returned 10.68 percent this September, while event-driven (merger and arbitrage) funds returned 9.16 percent, according to monthly statistics from the Credit Suisse/Tremont index.

So what’s been performing below par? The managed futures funds which bet on market trends by using computer models – they declined by 0.13 percent since the beginning of this year, said Credit Suisse/Tremont.

Managing Without Managers

-- By Pushpa Sathish, Staff Writer

Passive investing – that’s the new term being bandied about in the hedge fund industry. And it’s bound to get fund managers in a tizzy as it relates to removing them as the middlemen between the funds and their investors. The benefits are manifold in this initiative – managers’ exorbitant fees are removed, and investors’ portfolios are not fiddled with on a daily basis.

According to Ryan Tagal, director of hedge fund research at the Chicago-based Morningstar Inc., this scenario is academically possible, and can be implemented at a low cost. The picture painted looks increasingly good in the face of the fact that active managers are finding it very difficult to perform at a level that justifies their high fees. Courant reports:

Index mutual funds, as envisioned for hedge funds, tend to be somewhat different than mutual funds. The focus is not on replicating an index, such as the Standard & Poor's 500, but it can be on identifying the special elements that power various types of hedge funds, then building those mechanically into a portfolio.

Indian Hedge Funds Look Up

-- By Pushpa Sathish, Staff Writer

India is not known as a country celebrated for its hedge funds, but there are two in the nation that have made the top five among Asia’s best. India Capital Fund and Atyant Capital India Fund stood second and fourth in the list of best Asian performers with returns of 9.2 percent and 8.27 percent respectively, in the month of September.

These statistics are a result of research by global hedge fund tracking company Eureka Hedge, which claimed that Asian funds performed better than their American and European counterparts in September. Prodigal Absolute Return Fund, an Asian hedge fund, registered returns of 11.25 percent to take top spot in the list. Business Standard reports:

Traditionally, returns of hedge funds focusing on Asia tend to have greater market correlation than their counterparts in Europe and America. This is due to strong presence of long/short equity funds in Asia, most Of which tend to hold net-long positions, said the hedge fund tracking firm.

Hedge Fund Honcho Fined

-- By Pushpa Sathish, Staff Writer

The chairman and CEO of the hedge fund James River Capital Corporation has earned the ire of the securities regulators for his alleged illicit activities during trading in variable annuities. The National Association of Securities Dealers has fined Paul Saunders, a broker, a record $2.25 million and also suspended him from working as a broker for 60 days. The Chicago Tribune reports:

Saunders neither admitted nor denied the NASD's allegations. The NASD said the $2.25 million penalty was the largest fine it has ever imposed on an individual for alleged improper market timing, frequent "in-and-out" trading. That total includes restitution of some $750,000 in illicit profits that Saunders allegedly personally made.

October 28, 2006

The New Belmont Dynamic growth fund into the Canadian Market

By Priya Venkatesh, Staff Writer

Are you aware of the new Belmont Dynamic growth fund, which has entered the Canadian Market? Would you like to know further details of the fund? Just continue reading to know more on this fund!

Harcourt has joined hands with Royal Bank of Canada and has initiated the Belmont Dynamic Growth Fund in the first week of August, this year! Especially designed for Canadian investors, it is reported to offer shares in CAD & USD denominations.

Hedgeweek.com reports that this fund would be a high risk fund which is expected to bring high returns by investing with the existing Belmont fund managers who are believed to have inexplicable long-term expertise in this field! Hedgeweek.com reports:

Presently, the portfolio is tactically positioned having exposure to Asia, Europe, US Long/Short Equity, Fixed Income and Market Neutral strategies.

October 21, 2006

Hedge Funds’ Assets Rise

-- By Pushpa Sathish, Staff Writer

With all the money pouring into the hedge fund industry, the total value of assets under management rose to $1.34 trillion, according to a recent report from Hedge Fund Research Inc. (HFR). The Chicago-based firm said that more than 50 percent of the money was invested in relative value arbitrage, equity hedge, and event-driven strategies. The amount of money flooding the coffers of hedge funds does not seem to reflect on the performance of the funds though, said HFR president Joshua Rosenberg. Though the Q3 performance was not up to the standard, the strong investment showed that investors were probably considering the long term scenario, he added. Business Week reports:

On average, hedge funds returned just over 1 percent in the third quarter, putting performance this year through the end of September at 7.1 percent. The best hedge fund performers were convertible arbitrage strategies, up 2.74 percent in the third quarter and emerging markets strategies, up 2.6 percent in the period.

Former Treasury Secretary to Manage Hedge Fund

-- By Pushpa Sathish, Staff Writer

US Treasury secretary, president of Harvard University, managing director of hedge fund D.E. Shaw & Co. – the designations of Lawrence Summers make quite an impressive portfolio. Summers was treasury secretary during Clinton’s tenure in the White House. He resigned from his high-profile post at Harvard in February after a not-so-easy five-year term. D.E. Shaw manages around $25 billion of investor assets. Reuters Today reports:

D.E. Shaw, a multi-strategy hedge fund which specializes in mathematics-based “quantitative” strategies, didn't elaborate on Summers' new role at the firm, except to say he will help “identify and critically evaluate new investment opportunities throughout the world's capital markets.”

Senator Raises Regulatory Concerns

-- By Pushpa Sathish, Staff Writer

With more and more pension funds investing in hedge funds, a large number of people could be at risk of losing their retirement security, fears Sen. Charles Grassley. The senator, who is also the chairman of the Senate Finance Commission, has written to various financial regulatory agencies seeking more transparency in the way hedge funds operate and expressing concern over the lack of regulations for the industry. He was especially concerned about the lack of public information on the pension funds that had invested in Amaranth, and as a result, suffered losses due to the fund’s mammoth downfall. Chron reports:

Grassley, an Iowa Republican, wrote to Treasury Secretary Henry M. Paulson and sent copies to Securities and Exchange Commission Chairman Christopher Cox, Labor Secretary Elaine L. Chao, PBGC Director Vincent K. Snowbarger, Chairman of the Commodity Futures Trading Commission Reuben Jeffery, and several members of the Senate.