The problem with hedge funds

A new book that enthusiastically supports the idea of hedge fund investing may suggest to the non-specialist investor that these funds offer a road to riches. But while we do not want to stop anyone from reading a good tale in an entertaining book we want to point out a major problem for hedge fund investors. This is the regrettable fact that most of them do not really understand the risks that are involved in selecting funds. The marketing of Hedge Funds is often performed out of sight for the real end investor as intermediaries (in private banks and pension funds) are acting on a discretionary basis while bearing little of the ultimate risk themselves. Given the substantial cost of investing in Hedge Funds investors should employ independent advice before committing their funds and not rely on the judgement of those that have a financial interest in the transaction.

PS The title of Sebastian Mallaby's book is 'More Money than God'. This comes shortly after the confession by Lloyd Blankfein - CEO of Goldman Sachs - that he was 'doing God's Work'. Is there any connection between these two references to God?

How often do you have to check your portfolio?

An advertisement for a mobile phone application giving you instant updates on your portfolio is testimony to the increasing short-term orientation of today's financial markets. This is not the result for a real need expressed by investors but the outcome of a sales-driven culture that dominates the financial sector and seduces investors into excessive trading which creates a serious drag on the performance produced by investments.
Prices fluctuate from second-to-second and looking at these gyrations will only confuse investors. A sound investment strategy should instead focus on long-term targets and reduce costs and risks. Real-time quotes may have entertainment value but contribute nothing to the achievement of satisfactory investment results.

How 'independent' are financial advisors?

A new study by SEI discusses the concept of independence in the context of the money management business - with a special emphasis on retail investors and high-networth individuals. The study demonstrates that the customer of a money management firm has to understand the incentives of the advisor(s) in order to make sure that his portfolio is handled in the best possible way. When the chief executive of one of the leading investment banks and wealth managers states publicly that there is no moral obligation to take account of the customer's interests the importance of real independent advice becomes more relevant than ever.

Hedge Funds treat customers in discriminatory fashion

When even Antonio Borges, chairman of the Hedge Fund Standards Board (no, this name is no joke, though it is a misnomer if there ever was one), voices concerns about preferential deals offered to some investors and states that he "may" ask his member firms to bolster disclosure to other clients of the risks the practice poses, the lack of regulation in the hedge fund industry is laid bare for all to see. The "worrisome" practice used by more and more hedge funds of giving some clients so-called "side letters" and charging them a preferential scale of fees clearly demonstrates that the compensation and fee structure of hedge funds needs to be watched carefully by investors. These separately-negotiated agreements, which have attracted the attention of the UK's Financial Services Authority (FSA) in recent years, offer different investment terms to certain clients, some of which could disadvantage other investors.  We wonder why the FSA has not yet acted to protect investor's interests.

Be wary of forecasts and experts!

During a recent clean-out of the library I came across the following gem: In a review and comparison of the US and UK housing market published in 2005 the 'experts' came to the conclusion that 'there is no significant macroeconomic threat to home prices if our forecasts for interest rates and income growth pan out'. We can only say 'if the word if would not exist all forecasting would be much easier.

Former taxi-driver convicted for £37 million investment fraud

Investors were promised five-fold return on their investment.

Operational Risk often neglected

Most investors are focused exclusively on the quest for securing the best financial return on their investments. But recent developments have highlighted the need to ensure the safe return of the investment. Several prominent banks have been found wanting in protecting the confidentiality of client accounts held by their Swiss Branches. While no money was reported to have been lost as a consequence the fact that client records could have been transferred to a CD and the information offered to governments in surrounding states should set alarm bells ringing among investors. If it seems to be easy enough to steal customer data it may not be beyond some criminal mind to transfer money from client accounts. Clients are advised to conduct thorough due diligence on the operations of any bank or money manager they entrust their investments to. Slick advertising, tips from advisers or friends should not be the sole basis of picking a firm.

Confused by experts?

At any time you can find prominent experts predicting that a market will go up and the similar number of experts predicting that the market will go down. Now we all know that this is what makes markets and as a consequence one should never pay too much attention to any one opinion. But when George Soros states that gold is in a speculative bubble and at the same time his funds increase their long position in gold substantially one has to wonder why one should consider expert's opinions as more than background music.

Are Regulators asleep again?

There is still more talk than action in banking reform. We do not seem to be alone when making this observation. Volcker rule, Basel III, contingent capital - all these buzzwords are worthless if nothing gets implemented at some stage. News of generous bonus pools give the impression that all is back to normal in the banking world but when we had a look at the capital ratios of some large banks we were genuinely surprised - if not shocked - about the abysmal capital ratios that some of them reveal. Balance sheet totals seem to expand and the simple ratio of pure equity is in the low single-digits, and falling! So investors have to be more vigilant than ever when deciding how to allocate their investments. More than ever it is not the return on the investment that counts but the return of the investment.

Are there still any 'safe' Investments?

This question is often asked these day. And with good reason. A large part of investable assets are the debt obligation of states, regional governments, companies, private individuals and banks. While most bank deposits are guaranteed by governments that just pushes the ultimate responsibility for the repayment of bank deposits further up the chain. Only property, company shares and gold are assets that are not the liability of someone else. This explains the resilience of these assets in face of a shaky financial outlook.