Hedge Fund Catch-22

Here is one of the many reasons why you really shouldn’t invest in hedge funds.

There was a piece on Yahoo! Finance yesterday that touched on hedge funds and some of their problems. You’ve heard them all before. High fees. High risk. Lack of liquidity. etc. etc. etc. This Yahoo! piece was actually pretty benign toward the hedge funds. I think they were being way too nice.

But here is the real reason, and it doesn’t require endless charts of pseudo-reliable data. It is just deductive logic.

1. A hedge fund can only succeed at their special investment strategy if it is totally secret — meaning they don’t tell anyone what they are doing.

2. You’d have to be crazy to invest in a hedge fund that won’t tell you what they are doing with your money.

See the Catch-22? No matter what, you just can’t justify investing in a hedge fund.

Just to recap this point. If a hedge fund tells you how they invest, then their strategy can’t work. If they are letting people out there know what they are doing, the strategy neutralizes itself. For an investment strategy to work you have to know something that others don’t know. I discuss this point in another post — about how the few investors who can really beat the market keep their mouth shut about their investment ideas.

A better hedge fund manager will say “Sorry, I am not telling you what I will do with your money. I have to keep it a total secret for it to work.”

At least this guy indicates that he understands how markets work. In fact, this is how Long Term Capital Management did it.  Their strategy worked for several years until too many other people caught on to it.

But how can you possibly give your money to a guy who won’t give you a clue what he will do with it? You can’t. It’s crazy.

Either way, you can’t sanely invest in a hedge fund.

Photo by Steven Dopolo