Tuesday, January 25, 2005

Get the Hedge Out of Here!

The new Business Week blog just released a story on how overblown the hedge fund industry has become. The piece is quite pessimistic, arguing that the rapidly proliferating industry has bubbled--it is maturing too quickly and will hence return less than what we've become accustomed to seeing. Confused? Read further:
The industry is booming now, but new rules, subpar performance, and copycat mutual funds with cheaper fees may spark a shakeout...Assets of hedge funds have doubled from less than $500 billion in 2000 to almost $1 trillion today. As the boom continues, signs of its eventual cooling are clear. Factors such as new regulations, weaker returns, increased competition, and rising interest rates are combining to make hedge funds less profitable for both portfolio managers and investors. At the same time, mainstream mutual funds are adopting some of the same risk-reduction strategies popularized by hedge funds, making them viable alternatives to the pricey, exclusive investment vehicles. The result of all this will be a saner, tamer hedge-fund world in a few years. Regulation is the most obvious reason a more subdued hedge-fund world is on the horizon. New rules passed by the Securities & Exchange Commission in 2004 require hedge funds to register as investment advisers by February, 2006. New oversight will discourage hedge-fund managers from employing the kind of sophisticated trading and risk-taking strategies that have generated high returns aerage, hedge funds have underperformed both the stock market and the mutual-fund world for the past two years.
The article also pinpoints the ways in which the tightening of money will impair the way hedge funds operate & thrive because of
increasing expenses for hedge funds, which often seek to magnify their returns by borrowing money to invest. "Cheap money has been a big lubricant for financial markets in general and hedge funds in particular," says Panzner. "When you take that away, it raises the prospect of an adjustment."
Nevertheless, hedge funds still pique my interest if only because--to borrow from Groucho Marx--the only club I want to belong to is one that won't have me as its member.

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