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Hedge Funds Bushwhacked by Volatility

June 8, 2012

Hedge fund managers are warning their clients not to expect double-digit returns this year – should they know or care, having already clocked their 2% commission and, possibly, locked in our funds.

The recent volatility in the stock market, they say, is the wrong kind of volatility – it’s just up and down and up and down and all the stocks are rising and falling, rising and falling, like boats adrift.

What hedge fund managers really need is the other kind of volatility – basically, up and down and up and down, but confined more to individual stocks in markets that might or might not go up and down and up and down. Sounds profound, absent rocks and shoals.

Reuters – June 22, 2010 – J. Gaunt & L. Fletcher “You have higher volatility – which is good – but higher correlation.  So natural hedges are hard to put in place.”

One might think that the problem is further compounded by billions of pension fund monies now committed to glamorous and sophisticated hedge funds with good performance several years ago (not including 2007 and 2008, of course).

New York Times – August 3, 2007 – Jenny Anderson “On Monday, Sowood Capital … announced it would shutter its funds seemingly overnight, leaving Harvard’s endowment with a $350 million loss.”

This year, then, expect a cash return, that is, no capital gains,  from a properly designed “hedge fund” in volatile markets although many hedge funds are also slanted to the long equity return – if there is one and if they’re around long enough to find out.

If it does something else, then we won’t know what it is “until the tide goes out” (Warren Buffett) and we can see what “shorts” they’re wearing because hedge funds are unregulated by the SEC and don’t even need to keep audited books. We also have the further illuminating and sales worthy statement of Mr. George Walker, head of Goldman Sachs alternative investment strategies group, and second cousin of former President George Bush:

Forbes – May 24, 2004 – N. Weinberg & B. Condon “Sophisticated institutional investors have torn apart the hedge fund business. They’ve read or written the studies and know exactly what they’re investing in.”

Alas, it sounds hopeful and well-meaning but it seems that our retirement monies are being run by dupes, and we have only ourselves to blame. The better economists of today have long since denigrated mean-variance methods and the size, scope, and opportunities of today’s global financial markets suggest that the cherished and simplistic (statistical) model is nothing more than a skiff in thirty-foot waves.

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