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Hedge funds: a market for lemons? Print
This lack transparency is a common criticism about hedge funds. One exasperated critic from the blog has written a tongue-in-cheek letter doc.1036 by a hedge fund CEO apologizing to the fund investors. The letter begins: 

Dear Investor....
ACME Systematic Leveraged Macro Momentum Fund LP
321 Overprice Street
Greenwich, CT

Dear Investor,
This letter is to inform you that the wheels have come off of the proverbial wagon at ACME Systematic Leveraged Macro Momentum Fund LP, and that the same awesome thematic portfolio that made you feel (in the first half-year) as if you'd become very rich in comparison to those sucking wind on their leveraged MBS portfolios or Japanese Small-Cap Value Funds, has, quite literally, spontaneously combusted in our faces.

We encourage you to read the letter in its entirety, preferably after a glass or two of wine, since in the real world no hedge fund manager is ever likely to sign such a letter..

To counter this lack of transparency and to remind investors of their risky nature, one web site has been created to track the bad news about hedge funds; and what could be worse than hedge funds which literally implode. A web site has been created to do exactly that: see Hedge Fund Implode-O-Meter . As you will see, there is a lot of bad news out there that does not necessarily get picked up in the daily press.

OK, you say, maybe there is a transparency issue.  But hedge funds are a good diversification play, and hedge funds returns have a low degree of correlation (a good thing) with traditional investments. The only problem is that the low correlation story looks oversold. It turns out that hedge funds may suffer from contagion: when things go bad for one fund, chances are the same will occur for other funds. Want more: see the paper by Boyson et al 2007 doc.828.

Talk about bad timing. At the time we wrote the initial version of this commentary (November 2007) the financial markets were suffering from an unprecedented degree of volatility; see the Financial Stability forum announcement FSF October 2007 doc.830. In April in Europe there was already concern about the challenges of hedge funds to the financial system; see papers Bank of France april 2007 hedge funds doc.831. Yet in September two Bank of Canada employees came out with a paper reassuring everyone the potential risk from hedge funds to the stability of the financial system was small; see King Maier 2007 hedge funds and stability doc.829.

Hedge fund managers are very well paid. If the financial system goes to pot, we won't need to worry about the top hedge fund managers; see the study by Kaplan et al 2007 income inequality doc.832.   

We promise not to talk again about hedge funds again, at least for a while.

Last Updated ( Sunday, 26 October 2008 )
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