For those looking to make an investment, understanding what is ahead for hedge funds can mean the difference between achieving success and losing out. Hedge funds have not necessarily done well in some cases, and there have been insider trading scandals and other setbacks for this class of investments. Knowing how to identify the wheat from the chaff is necessary to avoid losses, or investing in something that later turns out to be untoward in this way. Nick Summers (2015) writing for Bloomberg Business has created a helpful overview that can be utilised to better understand the issues.
Hedge funds have received something of a bad press in recent years. As explained, a paper developed by Gerald Kerner, an industry lawyer that prepared it for an investment conference indicated some of the problems. The paper was called ‘Hedge Funds: Problems Under the Hood.’ Kerner made some interesting points. One challenge with hedge funds is that they may often end up with assets being completely locked up for a long period of time. Legal costs are also passed on. Additionally they are renowned for changing their rules. Kerner explained that the problem is that when rules are changed, no one is necessarily routing for the people that invested in the fund. And that’s a problem.
Some hedge funds have also been underperforming, giving hedge funds generally a bad name. It is argued that this has occurred more since the financial crisis and that these funds have been ‘lagging the broader market’. Examples provided are the Bloomberg Global Aggregate Hedge Fund Index which gained 2.1 per cent and did worse than the Standard and Poor’s 500 stock index. It is argued that underperformance has become commonplace and accepted. On the positive side this has led to increasing pressure to reduce the complexity that exists in the industry, and there has also been a call to reduce fees.
It is explained that Warren Buffett, a well known figure in the finance industry is anti hedge fund. Buffett said:
‘I would not go with hedge funds — would prefer index funds.’
He had emphasised the word ‘not’ by underlining it. Buffett has reportedly advised that expensive financial products should be avoided. For his part, he has invested 90 per cent of his own wealth into a low cost fund. This fund tracks the Standard and Poors 500 stock Index. If Buffett won’t invest in hedge funds, and the man knows a thing or two about finance, this has led others to question their own decisions.
All of this leads Nick Summers to propose an argument that hedge funds may not fare much better in 2015 either. Low dispersion and an absence of stock market volatility were given to be problems that also might contribute to low performance. Indeed, as Summers puts it:
‘Even when volatility did strike markets in October, funds that bet on macroeconomic trends posted their worst results of the year.’
This led to considerable losses for some, lowering confidence in the performance capabilities of hedge funds among some industry pundits.
Some hedge fund investors do well. An example offered is that of Bill Ackman of Pershing Square Capital. He is argued to have had a ‘big 2014’. However, it is argued that many more did less well and lost large sums. For example, it is reported that John Paulson, a billionaire waved good bye to 27 per cent in a key fund in November. Additionally, Meredith Whitney who is known for predicting the 2008 crisis saw loses of 11 per cent in her fund in November as well. Worse, Meredith Whitney’s company is now being sued in Bermuda. This is by a client that hopes to get a $46 million investment back that was lost.
However, other industry analysts believe the naysayers like Buffett will not really make a difference, stating that people will continue to invest in hedge funds. It is argued that more and more commonly hedge funds derive money from pensions, endowments and other clients like this. In 2008 figures for this were 45 per cent, but this has risen to 63 per cent in 2014, at least, so reports Preqin.