Hedge fund indexes - Healthcor Joe Healey

A hedge fund index reflects the average performance of hedge funds and makes that information available to those who seek it out. It may be investable or non-investable (and, in such cases, purely informative rather than an investment opportunity), and hedge fund indices are quite different depending on which “method” is used to collect and analyze the data. This is a simplistic outline of the different types of hedge fund indices, how they work, and some of the issues that arise with using hedge fund indices in the first place.

First, the question of usability must be brought up. Many people argue that hedge fund indices are unsubstantiated, are prone to bias, and cannot be relied upon. It is true that much of hedge fund index information is self-reported by hedge fund companies, which can lead to a bias. As hedge funds are private investments, there is no central agency to which they must report, and that makes finding hedge funds willing to divulge their returns and performance problematic in many cases. Do not forget that hedge funds are incredibly diverse, as well, and that information on one hedge fund may not remotely resemble information on another. This can make it even more difficult to collate data on hedge fund performance in a cohesive way.

The first form of a hedge fund index is known to be a non-investable index. This type is the one most prone to self-selection bias, as all performance information gleaned from hedge funds was gotten voluntarily. A non-investable index tracks performance in a variety of ways, using mean, median, and weighted mean, and as such, any result from a database search may not match another. Some people still consider it a valuable tool – and any information is better than absolutely no information, in any case.

The second form is the investable index. The main difference is that investment portfolios are created by the index manager, and interested shareholders can invest in the portfolios (as long as they accept all of the terms set forth by the index provider). This creates a functioning investment opportunity, very similar to a hedge fund portfolio in and of itself.

Finally, there is hedge fund replication. This tracks the historical performance of hedge fund returns, and using the data discovered, creates models that illustrate how hedge fund returns will behave under different investment scenarios.This model is also turned into a portfolio that can be invested in. This is the newest of the three forms of hedge fund indices, and because of its newness, there are still questions as to how well this hedge fund replication index method will work in the long term. It is not yet known how accurate hedge fund replication may be in practice.

Despite the drawbacks to using any of the hedge fund indices, there are some definite bonuses. Financial experts (and money managers) are able to study the hedge fund market to better understand how it functions and changes, and can adjust their strategies accordingly.

healthcor joseph healey

healthcor joe healey

Controversies and debates about hedge funds - joe healy

Hedge funds have seen their share of debate and controversy over the years, but none so much as after the year 1998. That was when Long-Term Capital Management, a speculative hedge fund in Connecticut, failed and required bailout from other financial companies and institutions. The failure of LTCM, which had been using absolute return strategies, shook up the financial industry, and many were gravely concerned about the future of hedge funds. When information about LTCM’s practices, including evidence of tax avoidance, became public knowledge, the media, the general public, and even some of the financial sector were up in arms about ramifications to the hedge fund industry.

Some saw the collapse of Long-Term Capital Management, and their alleged illegal activities, as a sign of pending doom for many other hedge funds. The bailout, which was under the supervision of the Federal Reserve, ended up costing financial institutions over three and a half billion dollars – and it was a desperate measure to stop the rest of the financial market from experiencing difficulties. The ultimate losses of LTCM cost around four and a half billion dollars, and the hedge fund eventually went under in 2000. With such a huge scare, and such a huge bailout, there was great concern about systemic risk (the whole financial system failing). Any hedge funds who acted similarly to LTCM were considered, by some, to be at risk of failure. Multiple hedge funds requiring bailout to stave off systemic risk was a very real possibility at the time. However, LTCM was the major failure and the biggest bailout to date, and there has not been any systemic failure before or after LTCM.

The fear of systemic risk is far from the only criticism that hedge funds have seen. A major concern with critics is the fact that there is so little transparency required in hedge funds. For one, it makes it difficult to track average performance of hedge funds when so few comprehensively disclose information. For another, a lack of transparency can mean a bigger opportunity for fraud, and there have been several big cases of fraud in the last several years that critics cite as evidence that there should be more disclosure and more regulation. However, hedge funds remain private investments, and are not – in most circumstances – required to divulge information to a third party. There is also a concern of conflict of interest in cases where Americans do not use third parties to act as custodians or administrators of their funds; in some such cases of proven conflict of interest, there have been allegations of fraud and securities violations.

Hedge funds may be debated in the public realm, and may be occasionally subjected to new rules and regulations, but it remains fairly unregulated compared to other investment types. Unless hedge funds are some day no longer considered private investments, there is no sign of this changing in a major way. The SEC does investigate allegations of insider trading and other fraudulent activities when it can, but it is not as involved with hedge funds as many would prefer.

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hedge fund joe healey

Are there risks with hedge funds? - joe healey

There are many risks that go along with hedge fund investments. To begin with, hedge funds often deal with large investment amounts, and while profitable returns on those amounts are highly satisfactory, when there is investment loss, it can be significant. Another aspect to keep in mind with hedge fund risks is the fact that they are considered alternative investment products, which are typically known to be high risk. 

Skilled managers do their best to see big returns on the invested money. They may use a variety of methods when managing the hedge fund portfolio -- and this can include leveraging, which is another method that has a steep risk. Leveraging makes investors big profits very quickly, but on the other side of the coin, it can also lead to big losses. Remember that hedge funds are primarily illiquid, unregulated (though the company/money manager must adhere to all trading laws, and the majority of investors must meet specific requirements to open up a hedge fund, the hedge fund itself is not regulated), and may involve hedging against market downturns. While there is often potential to see profitable returns even when the market is unstable, there is still risk.

Another issue with hedge fund risks that should be addressed is transparency. As hedge funds are private investments, the money manager (either a partner or a company/team) is not required in many cases to disclose valuation information, important tax information, and even the underlying investments themselves. Some of this information will be released to the investor, yes – but not always when the investor would find it crucial. The investor may not even know what information is useful to them in determining how the money manager is doing; the money manager is the one with skill and knowledge, and the investor relies on them for their expertise. If the money manager does not disclose information, it may stop the investor from knowing exactly how precarious their investment is. Many investors who would receive the information, and also understand it, may want the manager to make changes, or may consider taking their business elsewhere. The money managers have autonomy to make decisions without much disclosure, and in some cases, this can have negative consequences.

Hedge fund investments can be volatile. There are ups and downs in the vast majority of these investments, and it is up to the money manager to make the majority of decisions without much input from the investor. Putting that much power into a company or a person’s hands comes with its own set of risks; people are not foolproof, not matter how skilled they appear to be. Then you add in how tumultuous the market can be, especially when it comes to commodity trading, global markets, and other unstable situations, all of which are common to hedge fund investments. Investors must trust in the money manager to make aggressive decisions as to the “health” of their hedge fund portfolio, and sometimes the money manager will not deliver satisfactory results. 

hedge funds joe healey

hedge funds joseph healey

History of hedge funds - Joseph Healey

Hedge funds have become increasingly more well-known and popular over the last decade or so, after experiencing some historical ups and downs in terms of popularity. Hedge funds are certainly not new. This unique investment structure may have also changed a bit since its inception, but still resembles the original “model” of a hedge fund in many cases.

The person commonly credited with having “invented” the hedge fund is Alfred Winslow Jones (he also coined the term “hedged fund”). This Harvard graduate was a very remarkable man, and inventing the hedge fund was only one of his achievements. The hedge fund as we would recognize it in these modern times “debuted” in 1949, when Jones opened an equity fund as a private partnership. This did several things, and what was probably most important about it was that this merger meant the hedge fund was exempt from SEC regulation. Additionally, he combined leverage and short sales in a unique way to give him flexibility, and by doing so created a new model for investment practices. In 1952, Jones turned the private partnership into a limited partnership, and also paid a “performance fee” – these are two aspects of the modern hedge fund that are ubiquitous today. 

Once Jones established (or, according to people who do not attribute the invention of the hedge fund to Jones himself, popularized) the general structure of hedge funds, they caught on. People were intrigued by the chance to invest without slavishly following the market’s trends, and also by the chance to invest in relative secrecy, not being regulated by the SEC. Throughout the following decades, hedge funds rose in popularity. By 1968, there were nearly two hundred.

Things changed during the following recession and stock market crash in the 1970s. Because of the substantial loss that the financial sector had seen, fewer people were willing and able to deal with hedge fund investments. However, by the 1980s, hedge funds had increased in popularity and were coming out of the slump of the 1970s, where the majority of hedge fund investments were single-strategy. By the 1990s, the media had popularized hedge funds more than ever before, and they were considered lucrative and full of new investors because of the stock market rise at the time. As the decade progressed, more strategies were added to the hedge fund investment “repertoire,” and hedge funds became truly and incredibly diversified.

The heyday of the hedge fund was probably in the mid to late 2000s. However, with the financial crisis at the end of the decade came a drop in popularity for hedge funds. The difficult financial times meant that a portion of hedge funds failed completely, and investor withdrawals were restricted due to liquidity issues. Despite the difficulties presented by the credit crunch/financial crisis, hedge funds continue to be popular and to thrive. Though they are often high risk, and though there will probably always be hedge fund failures, this unique type of investment continues to attract investors from around the entire world.

hedge funds joe healey
hedge funds joseph healey