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Bonds Are a 'Safe' Investment: A Big Lie Gets Even BiggerWhat happens when too much money is chasing too few deals? In the end, the deals stop being such great deals.
A hedge fund might then keep the cash, patiently waiting for the right opportunity. This too has negative consequences though. The low yielding cash hurts the internal rate of return (IRR) creating a drag on the fund, and in turn, the reputation of the managers. Since the fees (1% to 2% of assets) and profit sharing, as much as 20% of the return over some minimum are based on success, time is not on the side of the hedge fund.
There are so many hedge funds in the market place with more being created all the time that the law of averages will reduce most to mediocrity. Like many things in the investment world, be it mutual funds, exchange traded funds (ETFs), closed end funds or analysts opinions, they are all carried to excess.
I would venture to speculate that traditional low fee index funds like Vanguard's S&P 500 fund or Total Stock Market fund will beat 80% of the hedge funds over the course of time, just like they beat 80% of the stock pickers in any given year.
The flurry of new hedge funds created over the last few years in response to investor demand has created a new source of revenue for the investment houses meeting this demand. It has nothing to do with rational investing and more to do with the interest of investors wanting to join the ranks of some exclusive group. Alas, the abundance of hedge funds has made them seem all the more pedestrian and they have lost some of their luster. I do not feel like I am missing out on anything, do you?
Having associations in the entertainment business I think there is a similarity between the movie industry and hedge funds. Both invest other peoples money (OPM), both have their 'stars' and most do not do very well under the light of day. Of course, when they do have something to crow about, in Hollywood or on Wall Street you can be sure they will take out full page advertisements in the appropriate periodicals touting some aspect of their success, however dubious, searching for more OPM.
OPM is another term for high leverage with low risk. Imagine how content you would be if you could make 15% to 20% returns on your money. Now consider how you would feel if you could do this without investing any of your own money. That's the world of hedge funds.
Those of you who are new to Bloggingstocks.com can check out my other stories and read Chasing Value or Serious Money to find more potential opportunities and verify my track record as well.
Sheldon Liber is the CEO of a small private investment company and the vice president for design and research at an architecture & planning firm. Check out his other posts for BloggingStocks here.
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