Handbook of Hedge Funds

23

Revisiting the Benefits and Risks of Hedge Fund Investing

For most people, applying intellect to investment is like trying to cut your grass with a vacuum cleaner

It may seem curious at this point to dwell on the benefits of hedge fund investing, as they are now well established and generally accepted by the vast majority of investors. Indeed, if you have managed to read up to this page, you are probably already convinced. But the important point with hedge funds is not simply to be convinced; it is to be convinced or unconvinced for the right reasons.

Hedge funds are entering the mainstream because they introduce a compelling new money management paradigm, which many investors are happy to embrace. Over the past few years, the difficult stock market conditions have made alternative assets in general and hedge funds in particular look like an El Dorado. Dazzled by the glitter of absolute performance, numerous investors have adopted hedge funds and included them in their portfolios, most of the time without really understanding what they were buying and with no clear understanding of the effective risk and return trade-off.²³¹

There are anecdotes about extraordinary profits made by hedge funds as well as rumors about incredible failures due to fraud or excessive risk taking. On the one hand, the legendary manager, George Soros, is credited with having compounded annual returns in excess of 30% after fees from 1969 to 2001. On the other hand, the over-leveraged Long Term Capital ...