HEDGE FUNDS CRAPSHOOT---THE SEQUEL

On October 31, 2007 I posted an article titled "Hedge Funds High Roller Crapshoot," in which the dangers of hedge fund investing were illustrated. Check it out in the Archives (lower left column.) While hedge funds themselves are geared towards the seven-figure net worth set, there have been a number of mutual funds introduced which invest in various hedge funds, and these mutual funds are available to Bill and Betty Barbeque. And Bill and Betty have been very tempted. So let's take an updated look at the hedge fund industry. The biggest difference between hedge funds and the race track is that hedge funds use bigger jockeys. Unless you're prepared to risk major losses, leave the hedge funds to the high-rollers who can survive losses in the hundreds of thousands of dollars. Yes, I know, their sales pitches are appealing, offering returns of 15%, 20%, 25%. Some, indeed, might have generated such returns. But that was then, when the market was riding high. Now, in today's volatile market, not only have hedge fund bettors lost their shirts, but many hedge funds themselves have gone belly-up. And there go the hedge fund jockeys new Mercedes's and Caribbean condos and shopping trips to Tiffany's. "...STAGGERING LOSSES..." The New York Times painted a chilling portrait of the hedge fund industry last week, in an article titled "Bad Bets and Accounting Flaws Bring Staggering Losses." If that headline has already convinced you to stay away from hedge funds, there's no need to read the rest of this article. Still with me? The Times article noted that the number of hedge funds has doubled since 2000, and there are now about 10,000 such funds managing almost $1.9 trillion in O.P.M. (Yes, that's trillion, with a T, a word you don't see often. And O.P.M. is the favorite playtoy of Wall Street's Wizards. It stands for Other People's Money.) It doesn't take a rocket scientist to know that when you have $1.9 trillion to invest, you have to be very creative to find that many investment opportunities that are somewhat understandable, minimally predictable and relatively legal. When you run out of the good opportunities, you have to start looking at junk. The crux of the article is in the following quote from Bradley Alford, founder of the prestigious Alpha Capital Management, an investment advisory firm: "This will be the year with the highest number of hedge fund failures...This year there's no clear trend and no safe place to hide." The Times also quoted a manager of a mutual fund that invests in hedge funds (see above) who asked not to be identified because he does a lot of business with hedge fund managers and, obviously, does not want to bite the hand that feeds him: "People who have been in the business for 20 years are saying January was one of the most difficult and challenging times they have ever seen." And finally, the words of Mark Fishman, co-founder of hedge fund Sailfish Capital Partners, whose recent collapse with $2 billion of O.P.M. under it's wing was the focal point of the Times article: "It feels like someone has died." SPECTACULAR FAILURES? The Times reporter, Jenny Anderson, sums up the situation in words that I can't make any more direct: "After years of explosive growth, this secretive, sometimes volatile corner of the financial world is entering a dangerous new era. The running turmoil in the markets is stirring fears that more of these funds will fail, some, perhaps, spectacularly." What do I say for an encore to that? Play it safe. The smart guys aren't so smart after all. [This article supplements Chapter 16, pages 421-424 in Personal Finance. Access the textbook by clicking on the box in the right column.]