Over the Hedge (Funds)

Most folks think that “hedge funds” were created for investors to literally hedge their bets by covering the downside of their investments with some fancy reverse strategy. That’s exactly what the people who coined the name wanted you to think. In fact, these are simply massive financial consortiums, catering only to those rich enough to meet their lofty investment thresholds. They have faced minimal SEC scrutiny due to the presumed level of investor sophistication, and because the “investment strategies” were entrusted to managers presumably with impeccable track records. I’ll put it another way, “Hey rich person, give your money to me and I’ll work my magic… with a few fees for me no matter what and a nice piece of the upside if I score.”

Some of these funds worked relatively well, and some, well…. You only have to look at Bernard Madoff's $50 billion Ponzi scheme, the largest fraud ever perpetrated, to watch as major banks, billionaires and the “who’s who” of New York’s and Florida’s mega-wealthy were taken to the cleaners, washed and hung out to dry. Charitable foundations and retirees found themselves virtually destitute in this incredible pyramiding scheme where the investments of the newbies were used to create “profits” for the old investors.

But hedge funds, who try to slow the exodus of investor cash with strict withdrawal rules (called “gates” by insiders) in order to preserve fees for the managers and prevent fleeing investors from reducing the value to those who remain, are losing cash at an alarming rate for any number of other reasons. Whether it’s folks who have other obligations (like margin calls from the brokers when the stock they borrowed against dropped below the required value to sustain the loan, or ordinary cash flow needs as credit evaporated), investors implementing their own “stop-loss” strategy or people who have simply lost faith in the system, this financial market sector – with a history of managing over $1.5 trillion – is watching monies being pulled out of accounts at a record pace.

TheDeal.com (December 15) projects that 2009 could see well over 30% of all of this money – which supports capital expansion and job growth – taken out of the system (and perhaps not actively reinvested as people move into conservative Treasuries or CDs). Things have been pretty bad in 2008 as well, and some financial gurus predict a much more disastrous scenario: “Hedge funds have racked up huge losses this year, ravaged by bear markets in both debt and equity, which have set off a tidal wave of redemptions by their investors. In October alone, the industry was slammed by roughly $100 billion in withdrawals, and earlier this year hedge fund legend George Soros said that the industry is being crushed, telling Congress at the time that ‘the bubble has now burst, and hedge funds will be decimated. I would guess that the amount of money they manage will shrink by between 50% and 75%.’”

In a world where the markets are always looking for the next shoe to drop (versus being thrown!), this is one of the next arenas where nervous investors have a lot to be nervous about. Money removed from active investment accounts to sit vapidly in conservative cash and cash equivalents most certainly will generate neither jobs nor long term economic values – the cash will sit and wait, and wait, and wait.

And then there are the private equity firms, another batch of funds that cater to the rich with limited SEC oversight, that buy or take control of entire companies (often with lots of debt that is carried only on the acquired company’s books), fix and then flip them back into the marketplace. With the value of acquired companies falling, paying the loans becoming problematical and the opportunity to sell the acquired companies vaporizing, nervousness abounds. There are lots of shoes in the news these days, but none of them seems to kick in any optimism. Where's Imelda Marcos when you need her?!

I’m Peter Dekom, and I thought you might like to know.