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.