Hedge Funds & The Comstock Silver Lode - Parallels?
Hedge Funds as we all know are hot. Pick up any financial paper or magazine and it's all the journalists refer to -
'Market up big today on Hedge Fund Buying'
'Market down today on Hedge Fund liquidation'
'When having lunch with a Hedge Fund manager the other day, he remarked...'
'Simon Someone, a Hedge Fund manager at XYZ partners is calling for a top in the Dollar citing these reasons......'
But perhaps a more interesting story that the media is missing is where exactly are all these funds going to generate their profits from? There are now nearly 10,000 hedge funds in existence with probably 60% being setup in the last 2 years?
The financial markets are no different from any market in that there's only a finite amount of profit to go around.
The Silver Comstock Lode In Nevada
In the 1850s prospectors first came across the famous Comstock lode of silver in Nevada arguably the single most significant mineral strike in history. The first few miners were obviously the ones to really strike it lucky.
But with news of the possible riches in the ground over 20,000 prospectors flooded to the area within a year, and what was left of the spoils had to be shared around. And of course not everyone made money, in fact its likely that the majority either lost or made negligible amounts.
The important point is that there was only a finite amount of silver to go around, there could never be anymore than what was in the ground already. The Comstock Lode therefore shares many similarities with the silver or gold rush in Hedge Funds. Profits cannot be magically sprung from thin air and if there's a £1billion (just an example) of profits to be made by x number of funds then this amount can only get diluted when an extra 9,000 funds (prospectors) enter the fray.
|
Virginia City, Nevada
Location of the Comstock Lode
|
|
|
Private Investors = Maybe Financial Cannon Fodder
This is why we feel that private investors such as ourselves are well advised to steer clear from Hedge Funds. As we don't have millions to invest we're simply not going to get the chance to invest with the best managers who by their skills and experience are going to have the best shot at garnering the profits on offer. Instead small investors are likely to have 4th and 5th tier fund managers who might strike it lucky, but the probabilities are stacked against them.
The Marketing Angle
One of the number one rules of business is to sell products or services that people want to buy. And Hedge funds have been marketed and spoken about with financial reverence. Just the name 'Hedge Fund' seems to translate into fantastic potential riches where the smart money finds its home. Again, this may well be the case for exceptionally wealthy investors but not for people with anything less than 7 figures to invest.
If many of the investing public now believes that Hedge Funds are the place to be and where the real money is made then the fund management companies will make it their business to sell these types of funds to their clients. Which of course gives the fund management firms more opportunities to legally skim all sorts of fees and other related charges from the clients capital. There's a joke at present which asks 'what's the definition of a Hedge Fund'?
A compensation scheme for the managers masquerading as an asset class for the investors.......
Summary
By all means invest in hedge funds but it's our advice to only do so if you have taken the time to fully investigate what and who you're investing in. But if you get sucked in by the marketing and general 'hotness' of the Hedge Fund sector then there's a good chance you won't get the returns you'll either be expecting, or you will have been led to believe.
So Where To Invest
This is always the million Dollar question. Some top notch clues can be gathered from an excellent piece of research from an IFA called AC Financials (see link at bottom).
The research main point is that investors are often looking the wrong way when deciding where to invest. They look for the 'best' fund managers etc but fund managers as the report proves are basically irrelevant. Instead investors should be looking to the right sectors because a monkey investing in the right sector will always outperform the world's best fund manager in the wrong sector. Remember fund managers have a mandate to have a significant chunk of their capital invested at all times.
For example -
- Say that the Banking sector had fallen 20% over the last 2 years and the Energy sector had risen 100% in the same time period
- All that the best fund managers investing in the banking sector could hope for is general damage limitation, investing in stocks that are perhaps unchanged or only down 10% over the time period
- But a monkey or even a 10 year old who randomly picked a selection of Energy stocks would probably have made at least 50% return on capital even if he had picked the worst performing stocks
- And there's always the chance that luck might have played a part and the selected stocks would be up over 150%
Don't Discount This Report
We would actually say that the AC Financial report into sector investing is one of the most important pieces an investor with a long term outlook can read.
To summarise, the report suggests that a mixed bag of the four main asset classes, stocks, bonds, cash and property (there are actually 28 different sectors, see report) would have yielded an annual compounded return of around 13% over the last 20 years. And that kind of performance is nirvana for many investors.
