The real secret of hedge funds

published 19 June 2006

Emerging markets could prove a problem for hedge funds, as it can be difficult to hedge to cover exposure when times are difficult, says Reuters. That's because not only are the markets very illiquid in times of turmoil, but they also have derivatives markets that are not as well developed as they are here. That criticism will no doubt add venom to Luke Johnson's own tirade against hedge funds in The Sunday Telegraph. Comparing hedge funds to the JP Morgan Fleming Mercantile Investment Trust, he says how the latter adheres to London Stock Exchange listing rulings, is audited by PriceWaterhouseCoopers and has a manager fully regulated by the Financial Services Authority. "No hedge fund can offer the same degree of real scrutiny and protection."

In addition, with fees of 0.5% of its market capitalisation, it is much cheaper than most hedge funds, where on top of a 2% commission you'll pay around 20% commission when the fund outperforms.

So why are people attracted to them? Johnson reckons it's because of the secrecy surrounding them, "with the implication that they have rare tricks that enable them to produce extraordinary returns". In reality, "hedge funds make their managers huge profits, so they can afford to bribe private bankers and others to push their products". At the end of the day, in the long run, "common sense investing beats smoke-and-mirrors tactics" every time.