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Hedge funds: smoke and mirrors or what?

Hedge funds have been in the news recently, and the FSA has expressed concern over the fact that small investors might become exposed to the risks associated with them through ‘exotic’ ISAs. The problem with hedge funds is that it is hard to see where their returns come from. To the extent that funds are effectively counterparties in hedging operations carried out by mainstream investment funds and other financial institutions then fair enough: they are simply being rewarded for providing a form of insurance. Like any other underwriter, if they get their sums right and don’t have too much bad luck then most of the time they will make money. Occasionally it will all go pear-shaped and they will lose a packet.

So is that it, or is the tail starting to wag the dog? If there is more money going into hedge funds than is needed for ‘legitimate’ hedging, then they must be betting against each other or betting very heavily against the markets. If a hedge fund makes money over and above what it could make from normal counterparty deals, then who is the money coming from? Like in any other form of betting, if there are winners there are bound to be losers. If you know the answer, tell us. A bottle of good wine for the best contribution!

 

  9 October, 2008 © 2008 K.R.Wade and Co Ltd prev page next page