Hedge Fund Frenzy Author: Adamheist
Hedge Funds are a bit funny; you have to pay 3 to 4 percent for management fees and other fees, plus about 20 percent of the profit, yet more and more people are crazy about them. For many years average hedge fund returns were 11 percent according to Business Week, but now the returns have become lower on the huge amounts invested in hedge funds. Maybe there is too much competition. Many smaller investors are involved in hedge funds through fund of fund groups, which require as little as a $25,000 investment, as opposed to a $1 million investment directly in a hedge fund. A fund of funds is a mutual fund that invests in several different hedge funds. This gives an opportunity for smaller investors, but the fees are higher, since there’s one more level of management to deal with. Altogether there is believed to be $1.5 trillion in hedge fund money in about 8,000 different hedge funds. They are under increasing pressure to be regulated after the largest collapse of a hedge fund ever, the Amaranth fund, which cost investors over $6 billion.
The other big thing hitting the markets is look-alike hedge funds, sometimes called ARFs (Absolute Returns Funds). These are similar to what ETFs, Exchange Traded Funds have been to mutual funds. ETFs are a basket of securities that are often designed to mimic mutual funds, but at a much lower broker’s fee. Look-alike funds mimic ETF’s relationship to mutual funds, by running profiles of the investment strategies of various hedge funds and mimicking them. Then the broker fee is only 1 or 2 percent, and there is no whopping 20 percent profit fee. These look-alike funds are definitely around, and if you ask your broker about them or do a few Google searches, you can get them. Although hedge funds total about $1.5 trillion in invested funds and mutual funds total much more money, about $8 trillion, hedge funds have an increased weight because of their use of leverage. At a ten to one ratios the effective investment power of the hedge funds can be greater than mutual funds.
To tell you the truth, if you read the financial press, it is a bit of a mystery what exactly the frenzied attraction to hedge funds actually is. They are invested in a combination of derivatives, mergers and acquisitions, selling short and some murkier deals in the “deregulated universe”. The danger is, as predicted by some soothsayers in 2005, that some funds will over-leverage and take excessive risks and go bust. That is exactly what happened to Amaranth hedge fund that had a $6 billion plus blowout on the oil futures market.