Comments on: Hedge Funds and Jim Gaffigan

By: Shannon Love

Shannon Love — Mon, 15 Oct 2007 15:18:23 +0000

Mitch,

Thanks.

By: Elliot

Elliot — Sun, 14 Oct 2007 22:19:19 +0000

I agree jumping ship when the going gets tough is often the best possible response.

If the Bear Stearns investors expected a total loss I doubt they would have invested in the fund. Had they only known about Gaffigan’s upside down ketchup bottles…

By: Mitch

Mitch — Sun, 14 Oct 2007 15:58:26 +0000

Shannon, you are right about that in terms of the original hedge funds. They were meant to either limit the downside risk or to hedge your other investments. If you own lots of stock, you might want a hedge fund account that either did things without high positive correlation to equity markets (commodities, real estate) or that actively shorted selected equities. Those funds are still around, but they are not the ones you see most often. Now they are looking for positive return, leverage, and (increasingly scarce) arbitrage opportunities, usually based on quantitative analytical models (evaluating markets as opposed to evaluating individual stocks). There is usually a good deal of macroeconomic prediction involved.

One menu for the “free lunch” was supposed to be “market-neutral” strategies, which in theory would make tiny gains no matter which direction the markets went. These tiny gains would be amplified by the leverage effect. This is the strategy sometimes described as “picking up nickels in front of the steamroller.”

We don’t always know what happens in hedge funds, since they don’t have to report anything, but if you look at the public mutual funds employing this strategy, you can see what happens when these models are stressed by unanticipated events like the sub-prime mortgage issue. It turns out that most of these models were only “market-neutral” within narrow ranges of conditions. Most got soundly thumped.

By: Good to Go Pile . . . « Trading for the Masses

Good to Go Pile . . . « Trading for the Masses — Sun, 14 Oct 2007 14:58:26 +0000

[...] Hedge Funds and Jim Gaffigan [...]

By: Shannon Love

Shannon Love — Sun, 14 Oct 2007 13:58:32 +0000

I thought the "hedge" in hedge fund meant that they tried to create a Dutch book with their investments. Was I wrong about that?

By: Carl from Chicago

Carl from Chicago — Sun, 14 Oct 2007 04:18:17 +0000

I guess the humor part of this was lost on you. Did you notice the Gaffigan reference, I thought maybe that would be a tip off.

I’d be interested in what the investors think especially in the recent Bear Stearns funds collapses. Did they expect that a fund investing in those types of instruments would be completely wiped out? Not from what I have read.

By: Carl from Chicago

Carl from Chicago — Sun, 14 Oct 2007 03:23:51 +0000

Good point of clarification. All the more reason to jump ship when the going gets tough…

By: Elliot

Elliot — Sun, 14 Oct 2007 03:15:48 +0000

“This was unexpected because the “hedge” in “hedge fund” implies that the assets were HEDGED in some manner, which means if the markets move in an adverse manner, the fund would be protected through the use of some sort of financial instrument or agreement.”

So, exactly who thinks hedge funds are protected against adverse moves? Perhaps those unacquainted with their operation and judging only by a two-word name might think that. But their investors don’t, and that’s what matters.

By: Jonathan

Jonathan — Sun, 14 Oct 2007 02:29:30 +0000

If the fund loses 20% in one year (not hard to do if you leverage money in a volatile market and it goes against you) then the next year they’d have to make up the cumulative losses of 20% BEFORE they earned a cent of performance fees.

Actually, in that case they would have to earn 25% (net of management fees) to be back to even. And depending on how much leverage the customers are using, they can lose most of their investment. (Not that the customers don’t understand the risks.)