You may not have heard more about hedge funds than reports that some multimillionaires have been making returns of 25 to 30 percent a year on investments of $25,000 and up. That’s true enough, but there is more to the story, and the plot is thickening.
For one thing, hedge funds have boomed in the past few years to the point where they now control assets of $1.2 trillion and account for a huge share of the trading volume on the New York Stock Exchange.
For another, returns of many of the funds have sunk to worse than the 9 to 11 percent year- to-date increases shown in equity market indexes.
More than 1,000 funds have shut down in the past two years, as big investors keep hunting for huge quick profits, less affluent investors get into hedge funds through “funds of funds” and new hedge funds keep entering the crowded field.
Financial sections of The Wall Street Journal and The New York Times carry almost daily accounts of the losses and collapses of major hedge funds. On a recent day, the Journal reported that assets of the Vega hedge fund empire with offices in New York, London and Madrid had dropped from $12 billion to $5 billion with investors rushing to the exits; Ritchie Capital Management LLC surviving a “near-death experience” as investors threatened a mass exodus over a controversial change in investment plans, and a potential battle brewing between hedge funds and private-equity firms over buying the debt of troubled and bankrupt companies.
Earlier, Amaranth Advisors LLC, a huge Chicago Fund, had offered to sell its investments after losing $6 billion in two weeks on bad bets on the natural gas market.
Hedge funds flourished as investment pools for extremely wealthy individuals. Some of the big retirement funds, university endowments and charitable foundations have put part of their assets into hedge funds in hopes of swelling their total returns from their more modest earnings from safer conventional investments.
Andrew M. Cuomo, Democratic candidate for New York attorney general, took a chance and put more than half of his campaign fund into a hedge fund. He lucked out so far, earning a 20 percent profit on a $750,000 investment in one year.
As conditions for big potential earnings, the funds typically lock in investments for months or years and restrict withdrawals by requiring advance notice or by temporarily banning them altogether. They often charge fees of 2 or 3 percent of the total investment plus a share of 20 percent of any appreciation. Secrecy, minimal government regulation and probably rampant insider trading are part of the deal.
The whole thing looks like a bubble waiting to burst, if only because it violates the truism that the greater the potential return the greater the risk. In the meantime, ordinary investors are getting the short end of the stick. Transparency and government regulation are urgently needed before this get-rich-quick obsession gets any worse.