Mutual Funds
You Name It, They Trade It
The hedge fund manager's answers to my questions revealed what I don't like about that style of investing.
By Knight Kiplinger, Editor in Chief
From Kiplinger's Personal Finance magazine, March 2007
Advertisement
The other day I spoke with a money manager who wanted me to invest with his firm. I had a lot of questions.
What do you invest in? I asked.
"Anything that we think is poised for a gain at any particular moment," he replied.
Such as?
"U.S. and foreign stocks and bonds, currencies, petroleum and metals futures, office buildings, start-up ventures, private companies, mortgages, shares of companies about to go public. You name it, we trade it."
How will I know which kinds of assets my money is in at any given moment?
"You won't. Our clients trust us to move their money in and out of all kinds of assets rapidly, and there isn't time to tell you in advance."
What trading techniques do you use?
"Any and all that we deem suitable to the circumstances: buying on margin, short selling, derivatives -- whatever."
Can I withdraw my investment on short notice?
"Actually, no. It would hamper our performance to offer instant liquidity to our investors. But after we've had your money for one year, you can usually withdraw it once a quarter or so, depending on market conditions."
What's the minimum investment for opening an account?
"We originally required at least $1 million, but we're pleased to announce a new program for the smaller investor, with an opening minimum of just $100,000."
What's the annual cost of your services?
"We charge you 2% of your account value each year, and we keep 20% of your investment gains."
Isn't that a little steep? After all, hot-shot mutual fund managers like Bill Miller at Legg Mason and Ken Heebner at CGM charge just 2% or less each year and there's no "incentive fee," so I keep almost 100% of my gains.
"Sure, they've done a great job of beating the big indexes year after year, but our firm is doing far better for our clients, even after we take our 20% off the top."
Can you send me some audited performance data going back, say, five years?
"Well, we started our company two years ago, and performance varies a bit from account to account. But our managers have great records from their previous jobs."
Is your fund registered with, or regulated by, any government agency or industry watchdog?
"Not at present, but I hear there's some talk about future oversight by the Securities and Exchange Commission."
Hedgehogs
If you haven't guessed by now, this pitch was from a hedge fund -- and I took a pass. The answers to my questions revealed what I don't like about their style of investing.
To summarize: Hedge funds are unregulated pools of capital that may trade in any asset class, with any methods they wish and without telling clients in advance how they plan to invest the money. They charge high fees and offer limited liquidity.
The pioneers of hedge funds included quite a few brilliant investors, and their returns were often eye-popping, as they darted in and out of undervalued assets all over the globe. But just as adding teams to Major League Baseball dilutes the average quality of pitchers, the proliferation of hedge funds has strained the supply of investment talent.
Not-so-spectacular
With hedge-fund managers often overpaying for the same foreign stocks, private-equity deals and initial public offerings, it's not surprising that average hedge-fund returns are coming down to earth -- and will likely flatten further.
But as competition for capital intensifies, so will the pressure to produce dazzling returns. Chasing big rewards always requires taking big risks -- with the potential for big losses. So when it comes to hedge funds, I'll just say no.
Columnist Knight Kiplinger is editor in chief of this magazine and of The Kiplinger Letter and Kiplinger.com.