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Steer Clear of Hedge Funds?

Not long ago everyone who was anyone wanted to jump into hedge funds. These days, you'll need to look very carefully before you leap.

"There are a lot of hedge funds out there that will go under in the next economic crisis," says Shonda Warner, managing director of hedge fund Chess Capital. "We are a lot closer to that happening than we were before - let's say we've gone over the hill."

Could the sub-prime crisis be the predicament that nudges hedge funds over the top? Last week Ivan Vatchkov, an analyst at Credit Suisse, said hedge funds are likely to see the biggest fallout from the collateralized debt obligation (CDO) crisis because they usually hold those sections of CDOs which are first in line for losses.

Warner believes it's a bad idea to join a fund right now unless you have plenty of experience - like 10 to 15 years' - in a bank. "Volatility trading is one strategy I'd be looking into, but you need a lot of experience to go in there," she says. She also advises conducting plenty of due diligence before you make a move. "You need to be sure the fund you join is truly hedging. There are a lot of hedge funds which are really just long-only funds and will do badly in a bear market."

Due Diligence

How should you approach due diligence on a hedge fund? Your best bet is to join one of the big established brand names, says the head of the hedge fund unit at a Big Four accounting firm. "The industry is diverging between the mega-managers and the smaller funds who are having problems attracting assets," he says.

If you do find yourself drawn to a smaller fund, scrutinise the track record of the people you're working for. "Where did they come from, how do they plan to attract clients, how well did they perform in their previous role if they were a prop trader on a desk somewhere?" says our Big Four source.

Given the secretive nature of hedge funds, how do you come by information on past performance? "You'll have to ask them how they performed," he says.

AUTHORAnonymous Insider Comment
  • Er
    Ernesto Kohn
    25 July 2007

    The industry is diverging between the mega hedge funds and everyone else. The mega hedge funds are replacing mutual funds/asset managers delivering stable returns with low volatility. Mega hedge fund managers can't afford the same risk levels that got them to where they are today.
    Joining a small/midsize hedge fund requires entrepreneurial spirit. New hedge funds will continue spring up at a faster pace then those who fold. The global economic upheaval will hasten the fall of many hedge funds. Thats the beauty of a free market.

    Manage your risk by doing due diligence on a hedge fund. Established brand names are no guarantee - Amaranth - Understand and question hedge funds...what is their value proposition... is it unique ...will it attract capital. Funds with a well defined value proposition will attract capital and grow over time. If you are entrepneurial by nature and like the space, you can manage your risk of the right fund for you by doing your homework.

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