Hedge Funds and the U.S. Financial Markets.

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January 9, 2006

SouthAmerica: Regarding the current state of the United States financial markets and the number of hedge funds that are going out business and being terminated - a book published in 2003 comes to mind: "After the Empire - The Breakdown of the American Order" by Emmanuel Todd (Columbia University Press - February 2004), this book was a best seller in Europe in 2003. Among a number of interesting facts that he mentions on his book; Mr. Todd wrote:

“Wall Street, where the leading indexes seem now to directly influence the trend of markets worldwide (up yesterday, down today), has become the endpoint of this security seeking mechanism – 3,059 billion dollars invested in US markets in 1990 - 13,451 billion in 1998. But none of this has much to do with the notion of economic performance considered in terms of real, physical productivity – even if the mantra of “new technologies” is a part of the process.

This increase in stock market capitalization that is totally disproportionate to the real growth of the American economy is nothing more than a sort of inflation of the rich. The extraction of profits swells incomes that are then poured into the market where the relative scarcity of the “goods” to be bought – stocks – produce increases in their nominal value.

…And one must not forget the constant lowering of interest rates – now to practically zero – which means in a speculative economy the free distribution of currency. But if we agree that the American economy is weak when it comes to real, physical productivity, as the massive and still growing levels of imports of consumer goods would suggest, then one has to conclude that the capitalization of the American stock and bond markets is a fiction and therefore the money that is traveling to the United States is literally traveling to a mirage and not the true oasis that many take it for.

…We cannot yet say whether the decline of the dollar that began in April of 2002 in the wake of the Enron-Andersen affair is just a small hiccup in the system or the beginning of the end. Nothing of the kind was either wished or planned, and surely the breakdown of the machine will be just as surprising as was its emergence.”


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SouthAmerica: How all this can add up to something that makes sense?

Today I have the feeling that the US financial markets became a “Fantasyland”. This is just an over simplification of the entire mess – but do we have more investment funds than stock of companies available for investment?

For all practical purposes:

The New York Stock Exchange lists 2,800 companies. The Nasdaq lists 3,300 companies. For a total of 6,100 public traded companies that other mutual funds and hedge funds can invest on.

There are 13,000 Mutual Funds and 11,362 Hedge Funds. For an estimated 24,362 investment types of companies chasing some kind of returns on their investments.

Consider the following:

Out of the 11,362 Hedge Funds – an industry not as regulated as the Mutual Funds industry – there are probably 10 percent or even more that are like a minefield hiding losses and manipulating the figures until they blow up like Refco and many others. There are many Refco’s out there waiting to go of.

There are many incompetent people among the people managing all these companies. And no one should be surprised to find out that there are a lot of greedy and unethical people among the people running these companies. Just look at the scandals we had in the last ten years and many of them involved billions of US dollars.

Today the Hedge Fund industry is like a minefield with a number of time bombs ready and waiting to blow out at any time.

And today many of the major American companies traded on the major exchanges – the way they are managed is nothing to right home about.


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1) The New York Stock Exchange:

NYSE-listed companies are among the world’s best. They range from “blue-chip” companies, to world-leaders in technology, to young, high-growth enterprises. They meet and adhere to the most stringent listing and governance requirements.

New listings at the Exchange include transfers from other U.S. markets, initial public offerings, and cross-listing by non-U.S. companies listed on other global exchanges.

In November 2005 the NYSE lists close to 2,800 companies.


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2) Nasdaq:

NASDAQ is the largest U.S. electronic stock market. With approximately 3,300 companies, it lists more companies and, on average, trades more shares per day than any other U.S. market. It is home to category-defining companies that are leaders across all areas of business including technology, retail, communications, financial services, transportation, media and biotechnology. NASDAQ is the primary market for trading NASDAQ-listed stocks.


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3) Mutual Funds:

Today “Morningstar” provides information on more than 13,000 mutual funds.


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4) Hedge Funds:

The amount of money managed by funds that can be termed hedge funds passed the $1 trillion mark during 2004, according to the Alternative Fund Services Review – and the total number of funds has broken the 10,000 barrier, reaching the grand total of 11,362.

The New York Times reported on January 7, 2006 that hedge funds assets have more than doubled, to $ 1.1 trillion dollars since 2000 – and hedge funds had an average return of 7.42 percent in 2005 through November.


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What's your point? Everything you mentioned is true. When "Paper Asset Mania" spreads to South America, you'll be glad.......mucha felicidad y dinero para todos!

 

Keep buying those T-Bills, Brazil Bagholders!

 

Interesting read South America;
especially about 11k hedge funds,11k mutual funds.

And isn't the average mutual fund about 10 or 100 times bigger;
1 billion would be small/med size for mutual find.
What say you?????????????

Liked your news piece on GM, many in market aparently thought same way;
don't think GM is a major benchmark though its well known brand
Some do.

Thanks/gracias.

 

RE 19.9 billion

Not going to GOOG all the entrys but on first page of GOOG;
but the '' average retirement oriented fund assets =$19.9 billion''.

And while I am reasonably sure thats larger than total average;
the point is average mutual fund is much larger than average hedge fund

 

I love how the people that complain the most about hedge funds are people who can't afford to invest in one.

It's usually the competition, which is understandable. Mutual funds, and the reporters they hire through advertising revenue, are finding out that their sales tactics are falling on deaf ears. There's only so many ways you can market a closet-index fund.

And Refco was not a hedge fund, it was a highly-regulated publicly-traded company. Makes you feel good about regulation, doesn't it? Costs people more money while offering no protection at all. It just provides a false sense of security.

Meanwhile hedge funds continue to grow despite the growing number of complaints. Why? Smart people continue to invest more while mutual fund cronies continue to complain more to no avail.

So go ahead and put your money in mutual funds. Meanwhile rich people can put their own money in hedge funds and normal smarter people to index ETFs.

 

First of all, your figure of 11.362 hedge funds appears incorrect. From all of the recent research I have read, the approximation is closer to 8000. However, the $1.1 trillion in assets is the going consensus as far as HF AUM.

I agree, mutual funds and the press love to view hedge funds in a negative light and sensationalize every blowup/ fraud case- the fact is, they are a relatively new investment vehicle, are only open to qualified individuals/institutions and only partially subject to regulation (there are loopholes to get a fund out of registering as an investment advisor). The average American lacks the sophistication or resources to fully comprehend hedge funds. What the public doesn't understand, they fear.

I can see that hedge fund returns have suffered in '05 as far as industry benchmarks. This is a function of the current markets as well as more managers, with more money, chasing the same opportunity set.

If returns suffer in traditional strategies, it is important to identify in a macro sense what the best sources of alpha going forward will be. An investor is not constrained to stale methods or managers. In fact, many new strategies have evolved, such as asset backed lending and hybrid funds (those with a hedge fund strategy and private equity component) In addition, funds have been focusing outside of the US markets, especially India, China, South America and Russia- and those funds as a group, have substantially outperformed the market recently.

The bottom line is, hedge funds, like all asset classes, will always have the funds that consistently outperform the markets, as a result of manager skill, those who track/slightly outperform the indices (which doesn't justify the fees) and those who simply fold within a few years of inception.

There will always be isolated cases where X mutual fund or whatever index outperformed Y hedge fund, but as an asset class, hedge funds have consistently outperformed mutual funds, ETFs, the S&P 500, etc (looking at data from 1990-2005- source: HFR).

 

Would it be possible that some hedge fund investors are virtually gamblers trusting in the hands of their gambling agents - hedge fund managers?

 

Not if you do enough due diligence

 

I love the image that many people have that 'hedge funds' are superior investment vehicles to almost everything else.

They're not, apart from a few good ones. It's a pyramid structure like anything else, a few few excellent funds right at the top leading down to the mediocre and then plenty of dross at the bottom whose investors can't figure out why their funds only went up 4.78% last year when 'hedge funds' are where it's at..........