Hedge Funds

[Adalbertus]

Recently, the G7 have agreed to impose a stricter control on hedge funds. At the same time they stressed the economic benefit of them. What I would like to know is what the economic benefit is.

As I see them, hedge funds try to increase wealth of the participants of the fund by performing highly speculative operations. Speculation is a zero-sum game which transfers money from bad speculators to smarter ones. This is superimposed on the rise (and fall) of companies who need money to get started or to grow in order to produce goods or deliver services, to provide employment and money for the investors. The latter of course is what I would see as economic benefit. But I don't see why speculation would help here. To get what I see as benefit, you need stable companies which then have a fairly stable share value (either increasing due to investments, or giving a dividend when not growing). This is not in the interest of speculators who want to get money from either rising or falling value. They (at least the smarter ones) then get maximum profits if the share values are volatile. Of course, having some power over the companies' politics, they try to make the share value volatile, which IMO is not in the interest of the "rest" of economy. So, where is the benefit (except for the profits of the investors in the better managed funds, which are countered by the losses of those who invest in the worse funds)?

[LordShiva]

Hedge funds aren't subject to the myriad restrictions that mutual funds must accept.

[OzzyKP]

Yea, you can really get stuck in hedge funds. Sometimes there is no escape.

[LordShiva]

[KrazyHorse]

Hedge funds have continually lost ground (their advantage relative to the market average has been dropping) since their inception. There's no need to regulate them. When they don't deliver market-beating returns on average people's appetite for them will drop (especially given their generally huge costs).

Personally, I wouldn't trust a hedge fund at all. I'll stick with index funds, thank you.

[LordShiva]

Hedge funds can do some badass stuff (generally with fixed income/foreign exchange). But the ones worth investing in are all closed to outside investors

[KrazyHorse]

Even those have been losing ground. Their bag of tricks is diminishing because others know them too.

[LordShiva]

Still, I'd invest all of my money and credit in Renaissance Technology's Medallion Fund in a heartbeat, if only they'd let me.

[KrazyHorse]

I agree that there are still tricks limited enough in circulation that some can make them pay. But it's not like 30 years ago.

[Drogue]

Re: Hedge Funds

Originally posted by Adalbertus
Recently, the G7 have agreed to impose a stricter control on hedge funds.

Sort of. The G7 really has little say on the regulation on hedge funds.

Originally posted by Adalbertus
At the same time they stressed the economic benefit of them. What I would like to know is what the economic benefit is.

Hedge funds provide absolute returns. That means anything that wants to grow at a sensible rate whatever the market does, needs to invest in a hedge fund of some sort. All it means is that it can go "short" as well as long (ie. can have a negative position in the stock, a bit like an overdraft, as well as a positive one) and can use leverage. Well-run hedge funds are of great benefit, the problem being that they're so easy to set up many of them are not well run. This is changing, as there becomes so many that people select those that do well.

Originally posted by Adalbertus
As I see them, hedge funds try to increase wealth of the participants of the fund by performing highly speculative operations. Speculation is a zero-sum game

Wrong. Speculation performs a valuable function of transfering resources from places where it is not doing well to places where it is, providing funding for growing companies by taking it away from those that will produce lower returns. As for highly speculative, investing is an *entirely* speculative game.

Originally posted by Adalbertus
They (at least the smarter ones) then get maximum profits if the share values are volatile.

Only if they predict them right. What a hedge fund needs is for it to have predicted right while others didn't get it until later. Shares, and any other investment, tend to be volatile around their true value (there's lots of statistical evidence for this), and as such, you only make money in the long run by being right before others are right.

There are problems with hedge funds, especially:
Understanding - most people don't know what they are and how they work, hence shouldn't be investing in them;
Quality - many hedge funds are badly run, and many well-run ones are closed;
Liquidity - you do not have instand access to your money, due to the size of the hedge fund (ie. being small).

Originally posted by KrazyHorse
Hedge funds have continually lost ground (their advantage relative to the market average has been dropping) since their inception. There's no need to regulate them. When they don't deliver market-beating returns on average people's appetite for them will drop (especially given their generally huge costs).

Personally, I wouldn't trust a hedge fund at all. I'll stick with index funds, thank you.

Actually, they deliever lower returns because they have lower risk. They deliver absolute returns, and thus are very useful for people who want stable returns, and are willing to give up some of those returns in order to avoid volatility. A well run hedge fund is exactly what a pension fund or life assurance fund needs, which accounts for ~75% of all investment in the UK.

There is a huge issue with quality though, in that many hedge funds are bad, as hedge funds are easy to set up and don't work if they have too much money. Which means you need a lot of them to meet the demand.

[KrazyHorse]

Actually, they deliever lower returns because they have lower risk. They deliver absolute returns, and thus are very useful for people who want stable returns, and are willing to give up some of those returns in order to avoid volatility.

You completely misread what I wrote. Please take the time to be more careful.

[Drogue]

What did I misread? Hedge funds are designed to lose ground, on average, to index funds, that's their point. Most people who invest in them (HNW individuals and funds, with emphasis on the latter) know this, and so demand isn't going to drop because they suddenly realise this. They know their performance, and are quite happy losing a couple of percentage points a year for the knowledge that they get absolute returns.

[KrazyHorse]

Also, I'd like to point out that hedge funds generally display a higher degree of risk than traditional mutual funds.

Providing uncorrelated returns has absolutely nothing to do with the degree of risk. You're basically talking out of your ass in this thread.

[Drogue]

Originally posted by KrazyHorse
Also, I'd like to point out that hedge funds generally display a higher degree of risk than traditional mutual funds.

How so? Any evidence to back that up?

Originally posted by KrazyHorse
Providing uncorrelated returns has absolutely nothing to do with the degree of risk.

Of course it doesn't. But absolute returns does not mean uncorrelated, absolute returns means stable, measured against 0, rather than an index.

[KrazyHorse]

Originally posted by Drogue
What did I misread? Hedge funds are designed to lose ground, on average, to index funds, that's their point.

a) No, they aren't. Hedge funds provide a generally better than average return.

b) What I said was that this advantage over the market average (i.e. an index fund) has been slipping over time, to the point where hedge funds provide only slightly better than average returns

Hedge funds were originally designed to provide a set of uncorrelated returns. Some hedge funds might choose to do this through a low-risk, fairly constant return strategy, but most hedge funds are significantly higher risk than a simple index fund.

I suggest you go look up the term "hedge fund" in any online dictionary and see what it has to say.