Hedge Funds emerged in the early nineties as an investment for wealthy investors.  By 1998, Long Term Capital Management (LTCM) was one of the largest.  It attracted the wealthy in New York and Washington, because the fund was a sure bet.  Afterall, the two people running it, both of whom won a Nobel Prize for economics, had figured out how to beat the stock markets.  Unfortunately, their theory failed in 1998 and the fund became insolvent.  The pursuing market crash nearly took down all stock markets around the world.  As a result, investors in Hedge Funds quickly liquidated their holdings, and much of the industry went into hibernation after a good two-thirds of funds went broke. 

After a few short years, investors returned to Hedge Fund investing because the funds only hired the best brains in the investment business.  By 2007, there were 15,000 hedge funds across the globe.

Hedge Fund managers became rich overnight because of their “Two and Twenty” fee, which entitled the fund to an annual 2% for management fee, plus 20% of all profits earned.  A small hedge fund, employing roughly 20 people, would easily generate a hundred million in fees per year.  It needs to be pointed out that during the 2008 implosion, the average fund lost 23%, and, not surprising, not one fund gave investors back their management fees.  After 2008, investors began withdrawing their money.  Within months, there were only 4,500 hedge funds remaining. 

The stock markets have done well the past couple of years.  This has created a surge in new Hedge Funds.  Today, there are 11,000 funds world-wide controlling $2.9t.  Because of the amounts these funds manage, stock markets can only offer so many opportunities for them to invest in.  As a result, they are now investing in private companies that cannot be openly traded.  We do not recommend these investments for conservative investors because this increases the risk level for the simple reason; how does one value a private company on a daily basis? 

CalPERS, California’s main public pension fund, is the sixth largest in the world.  Over the past 20 years, the fund has averaged an 8.4% annual return.  CalPERS farmed out some of their money to hedge funds over the past few years.  Recently, they fired every hedge fund as most never came close to equalling what the pension fund did on their own.   All investments will now be done ‘in house’. 

While a handful of Hedge Funds make investor’s money, the majority rarely do.  If this was not the case, the number of Hedge Funds would remain stable, rather than watching half of them close within a year in any down market.  We expect many of the funds to disappear in the months ahead.   

All Hedge Funds are high risk.  We recommend one avoid these investments.  Buying blue-chip securities that pay a regular dividend will outperform most hedge funds over ones lifetime.  This will remain the simplest, and most profitable, method of investing.