Wednesday, July 23, 2008

Ignore the Press, Hedge Funds are still a Viable Investment

The hue and cry from the press regarding Hedge Funds continues unabated. Obviously a good number of funds have blown up over the past year, causing a sizeable investor headache.

One recent article “4 Reasons Why Investors Should Avoid Hedge Funds at All Costs” outlines issues with oversight, managerial churn, investment concentration, and short life spans. These aspects should be concerns for many individual investors, but should not serve to rule out hedge funds as appropriate portfolio component for qualified investors. Despite the recent turmoil, Hedge Funds have a long history of serving the needs of qualified investors; one excellent summary of Hedge Funds can be found in the Knowledge Base section on the HingeFire website.

One financial industry issue is that everyone and their brother opened a Hedge Fund in the past few years. Most chased similar strategies involving credit spreads that all fell apart at the exact same time as the black swan came for a visit.

Most of these funds did not have a long track record and a number of the managers simply marched down the street and opened a new fund after the wheels fell off their previous effort. Investors need to differentiate between hedge funds with long track records, some spanning decades, and those opened within the past few years.

Hedge Funds should only be used by investors who understand the risks and expectations. During the past few years, the sales of Hedge Funds have gone down-market as the funds were sold to people who were marginally qualified, many times wrapped up by major brokerage firms as fund-of-funds (or a pyramid of fees). Certainly the unscrupulous account representatives made plenty on commissions but they were not selling a product that was appropriate for the customer. Many investors were convinced to place nearly their entire portfolios into Hedge Funds will the promise of huge returns, a good number of these individuals are now crying foul to regulators.

Hedge Funds are only appropriate for institutions and qualified investors who understand finance. These customers recognize the investment is long term and are using the funds as a diversification mechanism in context of a larger portfolio. Hedge Funds do have an appropriate place in the market. It would remain best that they are not regulated except for stronger restrictions on the qualifications of investors who can utilize these vehicles.

Before advent commodity ETFs and mutual funds, many well-heeled investors used funds requiring investor qualification for exposure to the commodity markets. Most of the funds were CTA/CPO run by individuals with Series 3 licensing. This was a very appropriate diversification method for investors with sizeable portfolios.

Hedge Funds are also in the forefront of offering products that are difficult to obtain exposure from using standard retail financial products; some examples include currency, private equity, and credit spreads. For qualified investors the Hedge Fund products serve as an important diversification tool.

Investors who meet the qualification requirements of Hedge Funds should not automatically rule out these investment vehicles due to all the recent bad press. An investor should evaluate the needs of their portfolio in regards to diversification, returns, and timeframe in order to make an informed decision about Hedge Fund investment. It is important to use on-line resources to properly investigate the returns, longevity, and track record of Hedge Funds rather than simply investing in a fund-of-funds pushed by major brokerage firms. Hedge Funds can serve an important role in your portfolio, and investors should approach these vehicles with an open mind, and more importantly with open eyes.