Summary
1. Hedge Funds have had a free hand until now. 2. Risk Management has taken a back seat for hedge funds especially in lieu of the bull market that has been in place since late 2002. 3. We need to get the SEC and the NASD, only to name a few to take a bigger role in analyzing the risk that hedge fund companies undertake.
Analysis
Have we all forgotten what happened with the mortgage industry in the early seventies when just like the present, individual investors lost money or at most received a few cents to the invested dollar? It was the same then and kind of the same now that in the final analysis, the individual is the loser. It seems to me that risk is almost always transferred to the individual investor and almost everyone involved prior to this transaction is not only not affected by this but in actuality has actually profited form these transactions.
We need to get the SEC and the NASD, only to name a few to take a bigger role in analyzing the risk that hedge fund companies are taking and thereby helping the individual. What we should have the SEC and the NASD to is to conduct a thorough assessment of the credit worthiness of companies and their risk mitigation strategy, analyze the exposure that a particular investment might affect the company as a whole.
The current sub-prime mess is no different. In most cases, the sub-prime derivatives did not have any real collateral, other than expectation of future cash flow and that also based on statements that were not verified by the mortgage brokers in the first place. Almost everyone is to blame here as all the mortgage companies and brokers did over the last few years was to determine the best way to package loans without any consideration to risk. For ex. Negative amortization, interest only loans, variable rate, and teaser loans. Many of these as I mentioned earlier came with either no documentation or documentation that was not verified. I would like to mention that not all hedge funds are alike.
I would like to bring special attention to Citadel, one of the few hedge funds that have thrived in 2007. I like their investment philosophy and their risk mitigation philosophy. They started off as tech-savvy, rapid fire trade to buy and sell securities and now account for almost 3% of the world-wide trading volume. They have truly grown steadily over the years and almost look like a large-scale financial company now. They wait to make the right moves, like salvaging Amaranth Advisors, Sentinel Management group and more recently parts of E*Trade Financial. Griffin is now planning to launch a futures exchange to rival the Chicago Mercantile Exchange.
Bottom line, not all hedge funds are alike but over the last few years or so, most of them have truly made bad investments, did not have a risk mitigation strategy and fared poorly. The sub-prime mess is showing its true colors now. It might be too late for many of the hedge funds to recover now but a select few that played by the books will survive.
