By Matthias Knab: My attention was drawn again to a paper on the current state of the hedge fund industry by Allenbridge HedgeInfo, which we already covered on November 12th (see here for previous article).
Allenbridge points out that the mainstream press is often full of anti-hedge fund rhetoric, wondering why the same misleading or untrue allegations are repeated over and over again.
The report was initially published before the Madoff scandal broke, and includes some discussion points which may be worth looking at again:
- Hedge Funds are too risky, aren't they?
- There is a grain of truth that some hedge funds are highly leveraged or have wild performance profiles. But in general, the exact opposite is true. Diversified hedge fund indices consistently show lower volatility than indices of blue chip stocks.
- Hedge Funds have too much leverage
- Some hedge funds work on high levels of leverage; but different instruments and markets behave differently. So 2x leverage in long/short equities is much more volatile than 2x leverage in convertible arbitrage. Average is probably about 1.4x (down from a high of about 1.8x in 2007). But we agree that some hedge funds have taken things to extremes, and up until recently no one felt strongly enough to stop them: clients could have walked away, prime brokers could have lent them less and regulators could have limited them.
- Hedge Fund Indices are rubbish because of survivorship bias
- Studies have shown that hedge fund indices are affected by funds which stop reporting, but it is wrong to suggest that only bad funds stop reporting. Good funds sometimes also stop marketing and reporting to databases when they reach capacity. But the allegation is particularly hypocritical because indices like the FTSE100 are founded on survivorship bias. At least hedge fund indices carry funds until they stop reporting, whereas the FTSE100 drops stocks because of poor performance.
- Hedge Funds blow up all the time
- Hundreds of hedge funds open and close every year, but the ones closing are more newsworthy. A tiny minority blow up, and this compares favourably with blue chip equities like Enron, Marconi, WorldCom, Parmalat etc. In the world at large, there will always be mistakes and frauds. We usually see hedge fund failures as being a symptom of inadequate due diligence, and possibly regulation.
- Hedge Funds caused the credit crisis
- Because hedge funds are usually prevented by legislation from answering back, many
people actually believe that this credit crisis is caused by hedge funds. The reality is of
course that bank salesmen discovered that no one was stopping them from giving loans to
Americans with no jobs and no money. The salesmen bank the commission. The bank sees
property prices rising, and keeps some for its own book and then makes a profit from
repackaging it for hedge funds or any schmuck who will buy it. When the value of the
hedge fund’s assets or the bank’s capital adequacy goes down, they give the hedge funds
margin calls, and the hedge funds sell whatever they can at the rapidly diminishing price.
Some hedge funds actual......................
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- Because hedge funds are usually prevented by legislation from answering back, many
people actually believe that this credit crisis is caused by hedge funds. The reality is of
course that bank salesmen discovered that no one was stopping them from giving loans to
Americans with no jobs and no money. The salesmen bank the commission. The bank sees
property prices rising, and keeps some for its own book and then makes a profit from
repackaging it for hedge funds or any schmuck who will buy it. When the value of the
hedge fund’s assets or the bank’s capital adequacy goes down, they give the hedge funds
margin calls, and the hedge funds sell whatever they can at the rapidly diminishing price.
Some hedge funds actual......................
