The Thing About Hedge Funds

Paul, the dirty little secret about hedge funds is that the term ‘hedge fund’ is itself a misnomer.

I am on a semantics kick today. As you can see over on the U.S. site, terminology is important, and one of the chief problems with hedge funds is that they are completely misnamed. Generally, hedge funds are not hedging anything, and too often they are either correlating closely to factors they are supposed to stand apart from, or, well, not representing much of anything.

That is why I’ve always been confused by hedge funds. And not only by the fact that the entire industry is by and large one of the largest wealth transfers from investors to managers ever (hedge funds generally take 2 percent of your money no matter what, and if you’ve had the wild luck to actually make some money once that’s deducted, they’ll take another 20 percent of that), but they frequently are not held to any standards, and are incentivised more to take wild risks in pursuit of alpha (or at least positive tracking error to the market) than they are to hedge anything.

And if we see wild skews in the returns of even traditional growth and value funds (which, like hedge funds, generally self-report their categorisations), these skews are often even greater within the various hedge fund sector indices, because these funds, which are highly opaque, may do things that are far from their stated investment goals as they pursue outperformance.

So my view is, and will always be, that while there is some real quality in the hedge fund industry, by and large it’s a racket, and an overpriced one at that.

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