Hedge funds are the fastest growing pool of capital in the world. From a handful in the early 90's they now number over 8,100 worldwide. That's on a par with the number of publicly traded stocks. Today, no one says gnomes in Zurich caused major market moves. Today, it's hedge fund buying or selling.

            Exciting, right?

            Hedge funds are even more interesting when you consider "membership." To invest in one you must be part of an exclusive club. You have to be an Accredited Investor. That's a person with a net worth of at least $1,000,000 and/or an ongoing income of at least $200,000 in each of the previous two years.

            Of course, a million isn't what it used to be. Neither is $200,000 a year. In America, we even number our millionaires in the millions! According to the Spectrem Group, which studies such things, there were 5.5 million households with a net worth over a million--- excluding their primary residence--- in 2002.

            Still, hedge fund investing is a lot more exclusive than investing in one of 13,000 mutual funds that require an initial investment of $3,000 or less. These dreary things are clearly for the Hoi Polloi, right?

Worse, most are tied to "style box" straight jackets and try to eke out returns that compare well to their benchmark index.

            Hedge funds go for high absolute returns. They take the risks necessary to make those returns. Some borrow heavily. Some deal in volatile derivatives. Some trade gigantic amounts of currencies or commodities. They make big money. They lose big money. The winners are celebrated. The losers disappear. Basically, hedge fund managers are the "high rollers" of the financial world.

            That's why I call hedge funds Vanity Capital. They make better status symbols than investments. Talking about your deal-arbitrage hedge fund may provide lots of psychic income at cocktail parties but it's unlikely to do much for your net worth.

            The reason, in casino talk, is "the Vig"---what the house takes. In a casino, the dummies play the slots. The Vig there runs 13 percent. The real gamers play Craps (Vig, 0.8 percent) or Blackjack (Vig 1.5, percent) where the odds are better.  Hedge funds are the slot machines of the investing casino.  Like a Craps player, the largest equity mutual funds cost less than one percent a year and may actually beat an unmanaged index. But hedge fund Vig runs four to five times higher.

Hedge funds often charge 2 percent a year plus 20 percent of profits. And that doesn't include serious trading costs. Investment master Warren Buffett charged only ½ of 1 percent plus 10 percent of the profits for his original investment partnerships in the sixties and still boasts that his favorite holding period is "forever."

His modest fees didn't stop him from becoming the second richest man in America.  Do you really think there are 8,100 people out there who are smarter investors than Warren Buffett?

            In hedge funds, like casinos, the house always wins. Some players in some funds will win. But most will lose because the Vig is always there, always skimming your money.

           

 

On the web:

 

The Hedge Fund Association: http://www.thehfa.org/

 

Hedge World: http://www.hedgeworld.com/

 

The Hedge Fund Center: http://www.hedgefundcenter.com/

 

Hedge Fund Net: http://www.hedgefund.net/

 

The S.E.C. on hedge funds: http://www.sec.gov/answers/hedge.htm