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Time to give hedge funds a wide berth?

Not long ago everyone who was anyone wanted to jump into hedge funds. These days, you’ll need to look very carefully before you leap.

“There are a lot of hedge funds out there that will go under in the next economic crisis,” says Shonda Warner, managing director of hedge fund Chess Capital. “We are a lot closer to that happening than we were before – let’s say we’ve gone over the hill.”

Could the sub-prime crisis be the predicament that nudges hedge funds over the apex? Last week Ivan Vatchkov, an analyst at Credit Suisse, said hedge funds are likely to see the biggest fallout from the collateralised debt obligation (CDO) crisis because they usually hold the sections of CDOs which are first in line for losses. Of a total predicted CDO black hole of 26bn, Vatchkov says only 2.5bn to 7bn is likely to reside with banks.

Warner says it’s a bad idea to join a fund right now unless you have plenty of experience (10 to 15 years’) in a bank first – “Volatility trading is one strategy I’d be looking into, but you need a lot of experience to go in there.” She also advises plenty of due diligence: “You need to be sure the fund you join is truly hedging – there are a lot of hedge funds which are really just long only funds and will do badly in a bear market.”

Doing the due diligence

How can you do due diligence on a hedge fund? The head of the hedge fund unit at a Big Four accounting firm says your best bet is to join one of the big established brand names – “The industry is diverging between the mega-managers and the smaller funds who are having problems attracting assets.”

If you do find yourself drawn to a smaller fund he says it’s all down to scrutinising the track record of the people you’re working for – “Where did they come from, how do they plan to attract clients, how well did they perform in their previous role if they were a prop trader on a desk somewhere.”

And given the secretive nature of hedge funds, how do you come by info on past performance? “You’ll have to ask them how they performed,” he says – which doesn’t sound particularly foolproof to us.

Comments (4)

  1. there are too many hedge funds with too many mediocre people in them. its time for a shake out.

  2. I totally agree with James. Too many mediocre players are jumping on the bandwagon and riding bull market luck. You only have to look at Amaranth to see what damage a lucky, inexperienced trader can do when the trend changes.

  3. Hedge fund managers have had it way too good for too long, because investors have been fooled by greed. Charging performance fees without any hurdles, and before the investor has had any chance to get paid himself, indeed perhaps losing a large part of his investment subsequently, has allowed manager, to laugh all the way to the bank in his tax-free domicile. How could there have been so many fools buying into this ponzi scheme? For every one truly talented manager there are ten or more with not much aptitude; just as in arts or sport, talent is rare. At least there, by and large, only winners earn, whereas in the world of finance… As to sharing the spoils: back to the middle ages where the owner takes all mostly free of tax and staff under PAYE pick up the crumbs.

  4. I gaze at the sky for a small correction downward, and that is good enough for (h)edge funds to go on the edge of the fall. Most of these so-called hedge fund / super performers have been on only long position and has spiralled the markets world over. Now they are wondering what to do next. Read Analyst comments for days expection and contradictory opinion on a daily basis. What is good for today is not same for tommorow. Where is the analysis ?

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