November 1, 2012 in Hedging and Hedge Funds
This is our concluding article on hedge funds, and a brief recap is in order.
We looked at what hedge funds are, their different kinds, the pros and cons of investing in them, a hedge fund gone wrong (LTCM), one of the most successful hedge funds in history (Bridgewater) and the fees structure of a typical fund.
By definition, hedge funds are higher-risk vehicles, often using large amounts of leverage, but able to deploy funds across a wide variety of assets, some of which may be illiquid, requiring the investor to lock in funds for extended periods of time. Since the hedge fund manager is paying himself first, and as we saw, his fees can be quite a packet, the manager must earn high returns to justify his fees and thereafter also provide a decent return to the investor. Yet, all of this must be achieved with acceptable risk!
All this leads us to an inescapable conclusion: most everything depends upon the abilities of the hedge fund manager – selecting the investment, determining the entry point, nursing the position, keeping risk at bay and finally closing the transaction with a decent profit without leaving too much on the table.
That takes some doing. It means you must be sure that the hedge fund manager has what it takes to achieve all of the above and some more.
An investment in a hedge fund is really an investment in a manager and the specialized talent he possesses to capture profits from a unique strategy.–– Sanford J. Grossman, The Wall Street Journal, September 29, 2005
Clearly, you are investing in the manager’s abilities. And you are duty-bound to your investment to conduct a sort of ‘due diligence’ of the hedge fund manager, as far as possible. How to do that?
Take a look at the educational qualifications of the manager. A good college record, preferably an MBA qualification, is a must for in depth understanding of the complex financial markets of the day. Studies have shown that better qualified managers earn better returns, gain more inflows into their funds and manage risk better.
The manager’s track record of managing funds should give you a picture of his abilities. Adequate experience is a must for managing funds, and to do so efficiently and with risk under control. Returns achieved on previous funds managed by him could provide a pointer to what to expect in the current fund.
Look up the manager’s standing in the market – that should not be too difficult a task in these days of the Internet, Facebook, LinkedIn and what-have-you.
Check that the manager is registered with the SEC as an investment manager. This means some screening of their background has already been carried out by the government.
Manager’s Own Investment
Hedge funds are very entrepreneurial in nature and most often their own managers also invest alongside outside investors. So, check that whether the hedge fund manager has also put his money where his mouth is! A substantial investment by the manager should be a source of comfort to you.
These actions should at least help to point you in the right direction, and avoid getting into funds that may be frauds or scams, at the very least, and maybe some decent returns otherwise.