This week’s Economist successfully nails blancmange to the wall

This week’s Economist contains a great analysis of how commonly-held beliefs about hedge funds may be urban folklore.  In fact, the piece makes so many succinct arguments, that we can’t really add much other than to suggest a few related AllAboutAlpha.com postings for anyone looking for additional perspective.

“Trying to assess the behaviour of hedge funds is a bit like attempting to nail a blancmange to the wall.  It is all too easy for the truth to slip away.”

“…Take hedge-fund failures. Most funds close down because it does not pay their managers to continue, not because their performance has been disastrous.  For every Bear Stearns ‘enhanced-leverage’ fund that loses all of its value, there are five or six funds that shut after a fall of a few percentage points…Doubtless more hedge funds will fail this year, but that will not necessarily be a sign of the industry’s demise.”

(Related posting: “Are some hedge funds sinking or just sailing into the sunset?”)

“…A survey by William Fung and Narayan Naik of the London Business School examined five different benchmarks and found that only 3% of constituents were common to all of them.”

(Related posting: “Only 3% of Hedge Funds in All Five Major Databases“)

“Although 2007 was a far more difficult year, the pace of extinction slowed.”

(Related posting: “Hedge fund closures to fall in 2010?”)

“According to HFR, the average hedge fund lost 1.8% in January, not long after another bad month, November, when the loss was 2.1%. A critic of the industry would take issue with such a record from an industry that claims to offer absolute (in other words, positive) returns. A true believer would retort that the S&P 500 index fell by 6% in January and that hedge funds did indeed act as a hedge.”

(Related postings: “August Redux? Some hedge fund indices lower and some higher than infamous month from hell.”)

“[The assumption] that hedge funds generally behave in a highly risky fashion also seems to be wrong.  The industry may be secretive but it cannot generally hide high-profile disasters.  And the credit crunch seems to have resulted in fewer disasters in the industry than it has in the investment-banking world.”

(Related posting: “January 29, 2008: The day the tide turned for hedge funds?”)

“Hedge-fund managers usually have a large amount of their capital invested in their funds—reason, indeed, why some of them have become billionaires. This commitment gives them every incentive to control risk. Bank traders, in contrast, are playing entirely with other people’s money; they get no credit for not losing money in a given year and are only likely to get a big bonus if they take risks.”

(Related posting containing some parallel insights from private equity world: “New research on private equity surprises even some of the experts.”)

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