Hedge Fund Woes

Pirate Capital LLC, an activist hedge fund manager said Thursday that its investment staff will be cut in half and its fund will be closed to new investors. Another hedge fund manager, Amaranth Advisors LLC loss a whopping US$6 Billion betting on the wrong side of the market. Add to this several other hedge funds which has either closed down or stopped accepting new investors due to poor returns.

The bull market in commodities created a slew of hedge funds banking on investors wanting to get into the game. A lot of Income Trust and REITs were also established to capitalize on the real estate boom as well as the oil boom.

Most of these funds have a track record of less than 5 years. Yet investors are willing to invest in these funds just because they are the darling of the fund rating companies or they achieved spectacular returns in their first few years, some making over 105% in one year.

It seems to me that people never learn. Don't they remember the recent crash of the stock market due to the Internet Bubble in 2000? How about the crash of 1987? Or maybe the bear market in oil in the early 1990s?

These are fairly recent events and yet people forget about them. They invest in hedge funds without thinking of how this fits in to their overall portfolio or whether these companies have a long enough track record.

Although only qualified investors (those who make at least $200,000 a year or have more than $1 million in assets) are allowed to invest in a hedge fund. It goes to show that the rich are also subject to the crowd mentality

There is nothing wrong in investing in a hedge fund per se, but investing just because of a recent spectacular return is the wrong way of doing it. There are a couple of great hedge funds out there like those run by Bill Dunn, Ed Seykota, John W. Henry and funds by Man Investments. These funds have over 20 years of history and although they suffer losses from time to time, they have shown they know how to limit their risk and recover from their losses.

Before you invest your money, you should do you homework. This goes for any investment whether stocks, bonds, mutual funds or investing in a new business.

As Warren Buffett says:

Rule 1 - Don't Lose Money
Rule 2 - See Rule 1