Who Hedge Funds Really Work For

Nice little story in the Times this morning about [tag]hedge funds[/tag] and the people they’ve hurt. As everybody should know by now, you’re really no better off, on average, in a hedge fund than in any other investment vehicle. In this article, we get the story of one man who lost his 250k investment in the [tag]Bear Stearns[/tag] blowup.

The most striking thing about the behavior of hedge funds over the past few months is that they’ve made perfectly clear that while they are increasingly willing to accept investments from non-institutional clients, they are not interested in serving the interests of those non-institutional clients. Incorporating and shielding assets in the Caymans isn’t a rare or shocking tactic, but misleading people about the quality of the structured debt you’re carrying should be both rare and shocking to anyone who cares about a sound financial system.

Another noteworthy aspect of this story: the investor wasn’t exactly looking to get rich quick:

Mr. Greene, a former engineer, said he invested in several hedge funds in recent years, aiming to preserve his principal. Most of the funds have worked out well, he said, producing slightly better-than-market returns with little volatility. He estimated that he has $600,000 to $800,000 invested in hedge funds. He invested in the Bear Stearns fund in October 2005, and he said the fund appealed to him because its returns of about 1 percent a month did not seem to fall into the too-good-to-be-true category.

So a wealthy individual looking for 1% monthly returns puts some cash into a hedge fund, the fund blows up, and the individual is probably left with nothing (he will be the last to get paid). You know who else sought very modest investment returns, watched their assets disappear almost overnight, and was pushed to the end of the line when settlements were paid? [tag]Enron[/tag] employees, that’s who.

Maybe it sounds a little hyperbolic to compare Bear Stearns to Enron. But as far as we’re concerned, financial institutions have the burden of proof to demonstrate that they’re not crooks, and so far many hedge funds have not met that burden. Hedge funds abuse their use of leverage, they mislead investors about the dangers and details of their activities, and most importantly, they completely fail to do the one thing for which they were created: they don’t hedge risk! A hedge fund that takes on absurd levels of risk (as so many seem to do) is nothing other than an unregulated pool of casino money.

One reason we started this site and our [tag]iron condor[/tag] newsletter was to teach individual investors to take control of their own financial future. In all honesty, we would prefer a regulatory regime and a political environment that didn’t simply hand unlimited power and infinite protection to the wealthiest and most powerful elements of corporate America. But regardless of whether hedge funds even learn to govern themselves, or continue to act irresponsibly (forcing someone else to govern them), the same conclusion holds for individuals: you’re better off either trading conservative strategies like ours, or in hands-off index funds.

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Jared Woodard specializes in trading volatility as an asset class. With over a decade of experience trading options and other volatility products ... Read More


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