What's Wrong With Hedge Funds Today?

By Author: blackhawkpartners
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Sociologist, author, and financial journalist Alfred W. Jones is credited with the creation of the first hedge fund in 1949. Jones believed that price movements of an individual asset could be seen as having a component due to the overall market and a component due to the performance of the asset itself. To neutralize the effect of overall market movement, he balanced his portfolio by buying assets whose price he expected to be stronger than the market and selling short assets he expected to be weaker than the market. He saw that price movements due to the overall market would be cancelled out, because, if the overall market rose, the loss on shorted assets would be cancelled by the additional gain on longed assets and vice-versa. Because the effect is to 'hedge' that part of the risk due to overall market movements, this type of portfolio became known as a hedge fund.

Estimates of industry size vary widely today due to the absence of central statistics, the lack of an agreed definition of hedge funds and the rapid growth of the industry. As a general indicator of scale, the industry may have managed around $2.5 trillion ...
... at its peak in the summer of 2008. The credit crunch has caused assets under management (AUM) to fall sharply through a combination of trading losses and the withdrawal of assets from funds by investors.[ Recent estimates suggest that hedge funds have more than $2 trillion in AUM.

A recent survey of hedge fund administrators indicates single manager hedge funds have over $2.5 trillion in assets under administration
As to returns, it has been pathetic to say the least. Take a close look at this latest article from AR Magazine (owned by Institutional Investor) http://www.absolutereturn-alpha.com/Article/2720404/Hedge-fund-IRR-has-been-pathetic.html and see for yourself.

Bottom Line:

Hedge funds started out being viable investment vehicles for those with enough resources to hedge against adverse market moves. Today, most investment managers are though taking advantage of the regulatory loophole to open hedge funds not using any hedging strategies at all. These "fake" hedge funds are what this blog is all about.

Hedge funds were initially designed to be "market-neutral" by always holding investments that will go up when the markets go down. This means that no matter what the markets do, you should always make money via the spread, which is usually substantially more than the T-bill rate. Hence, even if the stock markets went down 20%, you'd probably stand to make about 5%. True hedge funds still follow this strategy. This investment methodology, and the investor net worth restrictions, allows them to circumvent SEC regulations on pooled investments (via the Investment Company Act).
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