Hedge Funds Get Clipped
Slim gains and scandals turn off investors
In fact, retail investors can gain easy, if costly, exposure to hedge funds by investing in "funds of hedge funds," some of which require only $25,000 in initial assets. The practice has caused enough concern that David Swensen, chief investment officer for Yale University and a longtime user of hedge funds in managing Yale's $14 billion investment portfolio, recently called for the elimination of such hedge fund baskets in a New York Times opinion piece. He also goaded regulators to "prohibit unsophisticated players" from investing in hedge funds at all.
Some investors may not even be aware that their money is already tied up in a hedge fund. Institutional firms that manage small investors' money, such as pension funds, are becoming increasingly big users of hedge funds. The California Public Employees' Retirement System, the nation's largest pension plan, has about $1.2 billion of its $200 billion portfolio invested in hedge funds and plans to nearly double that stake soon to increase returns amid an increase in expected retirements. Charitable money is ending up there, too. The Jewish Federation of Metropolitan Chicago, for instance, says it lost $4 million in the Bayou implosion.
Universities, such as Harvard, and religious institutions, like the Roman Catholic Church, among others, are hedge fund investors. Although private investors and money managers may be cooling to the investment vehicle, U.S. institutional investors, such as pension funds, are expected to increase their stake in hedge funds to $300 billion by the end of 2008, a 400 percent increase from 2004.
Maybe all these hedge fund investors will make a killing. It's not that there aren't opportunities left. Hedge funds are finding an increasingly wide array of investments to dip into, from buying distressed debt and emerging market assets to taking positions in complicated and sometimes illiquid derivative products. Some funds are attempting to tackle the competition, the risk, and the lackluster returns by diversifying into several strategies at once. Others are looking for the next big thing, like debt instruments tied to lawsuit payouts, or life-insurance financing, or catastrophe bonds, also known as CAT bonds, which are a form of insurance for insurance companies if their losses from a hurricane or other natural disaster exceed a prescribed limit.
But successful strategies draw a crowd, and none are foolproof--just ask the hedge funds that got burned on CAT bonds when Katrina hit. And there is no telling whether most or even many of the 8,000 hedge fund managers out there are nimble enough to stay ahead of the curve--or whether investors can find the ones who truly are.
In the long run, hedge funds are likely to prosper only as long as their returns beat the market over time, and Aaron for one is unwilling to take those odds. "You're either in with one of the truly great managers of the world or you're not, and if you're not in with one by now, they won't let you in because they don't need your money," he says. What's left? "Pretty mediocre pickings."
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