August, 2005

Anybody out there heard of hedge funds? All the rich folk have, for sure, because that used to be a very carefully protected investment gig . . . secured against incursion by the common folk by the entrance fee, which was always negotiable but up towards a million a throw. Kept the riff-raff out.

But the riff as well as the raff are allowed in these days because, greed being what it is, there’s always someone interested in big numbers and big numbers come from small investors.

Funds made up of funds, pretty much like the idea behind mutual funds, now have aggregate investment portals as low as $25,000 and they are themselves aggregates, putting together a couple dozen $1,000 rollers to make the ante.

The trouble with hedge funds, in simplified terms, is fourfold

• Hardly anyone really understands them, even the brokers who sell them
• There’s no certified and standardized ‘entrance exam’ for fund managers
• They’re for the most part unregulated
• They leverage their investments to the extreme, because they are allowed to do so

The reasons ordinary investor-type folk overlook these composite troubles are pretty straightforward; hedge funds have a history of performing well in either up or down (or even flat) markets, everybody loves a sure thing and investors, like most of us, believe what they really want to believe.

Of course the last time we allowed really extreme leveraging of investments (also known as buying on margin), we got the ’29 crash for our efforts but that’s way back there with the Civil War in anyone’s current memory.

Remember the sure things in investing? You’ll have to scratch your head as they were all of them disproved and a hundred thousand men were broken financially until the markets righted themselves. Yet the myths survive. We are hardly out of the dot-com bust, not yet entirely dry from that bath and pounding our heads furiously that we weren’t prescient enough to max out our portfolios on Google. It matters not that serious-minded folks ten years back actually believed in a Dow-Jones at 30,000 (books were written) and the financial pages were full of articles about the new investment parameters . . . a modern financial paradigm . . . the lid was off.

Unfortunately for a lot of investors, so were the prognosticators. The Dow-Jones has lain on its side like a sick goldfish for five years now, stuck in the mid 10,000 range and unable to flap a fin.

But good news is (supposedly) here with an investment opportunity never before available to the little guy and only a fool would speculate on why a solid-gold deal, available only to the rich, would suddenly arise like a Phoenix before the small investor. Could it be the rich are pulling out? Could the mine possibly have played itself out? Could it be that large numbers of the unsophisticated are required? Possibly. Quite possibly.

Fifteen short years ago there were 600 hedge funds, surely sufficient for the grazing needs of the super-rich herd. Today there are over 8,000 and the grass is pretty thin in all those pastures.

Voila!

Whistle up the sheep. As you’ve all heard me say about my old daddy, he marked off Wall Street into the sheep and those who sheared the sheep. Trimming a hedge . . . shearing a sheep . . . same metaphor, different decade.

Unlike fifteen years ago, but very like 76 years ago (quickly now, 2005 minus 76 makes what? . . . arrrggghhh, 1929) hedge funds are allowed to borrow who-knows-how-much in order to bet who-knows-what will either go up, down or who-knows-where. That’s an absolutely classic definition of an ungoverned market.

And thus we have the ungoverned and inexperienced leading the unsophisticated and insouciant into the unknown and indefinable.

It's hard to know who's holding the shears.

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