Thursday, October 21, 2010

Bad Advice: Creating Your Own Hedge Fund

CNBC has an article on how to build your own hedge fund which tops the list of potentially devastating investment decisions you can make. Hedge funds are investment vehicles typically limited to high net worth investors which can use a variety of investment strategies that the average investment fund cannot. These funds can employ large amounts of leverage, short stock and trade derivatives, among many other things. While we have all heard of the wildly successful funds like Ken Griffin's Citadel Investments or John Paulson's Paulson & Co, there are thousands of funds that fail for each one that revels in exorbitant returns.

Retail investors are at a disadvantage to hedge funds and other institutions because those firms typically have large amounts of capital to move around and with that capital comes speed, efficiency and information flow which helps them make money on their trades. Secondly, the people who run hedge funds are typically brilliant financial minds, and while brilliance does not equate to consistently posting market beating returns, the minds at hedge funds usually understand the nuances of the securities and markets in which they trade.

All of these reasons make CNBC's article - how to start a "poor man's" hedge fund - ridiculously bad. After all, if the financial crisis saw many of the aforementioned brilliant managers blow up given large derivatives exposure, how can the average retail investor navigate the derivatives market successfully? In short, we can but the odds are against us. More importantly, who has the time to bother to trade and understand currencies, commodities and long and short positions? The pros at the large hedge funds do - they employ thousands of experts in each market - but the average investor like you and I certainly have more important things to be doing.

Sure, creating your own hedge fund sounds like a neat idea. The thrill of beating the market as well as the pros at their own game, certainly holds a lot of appeal. However, when you realize that the odds of this occurring, especially with any consistency, are slim to none, why not save yourself the time and aggravation involved in this endeavor and instead just buy index funds?

No comments:

Post a Comment