Hedge fund boom bound for bustville
Commentator David Frum
TEXT OF COMMENTARY
Lisa Napoli: Tuesday was not a happy day if you own a piece of The Blackstone Group. The private equity fund slipped more than 5 percent below the price it collected in its initial public offering last week. That Bear Stearns bailout of one of its hedge funds is making people nervous about the cost of capital and the cost of possible investment mistakes by places like Blackstone. So says commentator David Frum.
David Frum: The troubles at Bear Stearns are not a storm, not even a shower. But they are the first drops of rain from an overcast sky.
Not so long ago, the hedge fund was an exotic investment vehicle for the very sophisticated and the very wealthy. Often based outside the United States, exempt from U.S. securities regulations, hedge funds could pursue above-market returns by accepting abnormal risks.
In return for these huge rewards, hedge-fund investors paid huge fees — typically 2 percent of all the funds invested, plus 20 percent of the gains earned with their personal contribution.
It must have been worth it, because hedge funds proliferated. Today it's estimated that there are 8,000 of them.
Not much is known about these funds. They do not have to report the way a mutual fund does. But here's a safe prediction: It is not possible for 8,000 funds to beat the market, year in, year out.
Hedge funds originated as devices by which canny investors could short overvalued stocks. They have evolved into vast private-equity firms that offer companies an often appealing alternative to public securities markets. But as with any innovation, there is a lot of exuberance and excess mixed in with the new and valuable.
Many of those extra risks the funds take will go bad, and many of the investors paying those hefty fees will wonder whether they might not have done better to pay less for safer and more traditional investment management.
If there is a shock — I mean, when there is a shock — the industry will shrink. Gradually if we are all lucky, very suddenly and very frighteningly if we are not so lucky.
The hedge fund as an institution will continue. But the hedge-fund boom of the '00s will be remembered along with the dot-com boom of the 1990s and the S&L boom of the 1980s as one more reminder that while a skillful and fortunate few of us may sometimes beat the market, most of us are the market.
Napoli: Thata€™s commentator David Frum of the American Enterprise Institute. In Los Angeles, Ia€™m Lisa Napoli, enjoy your day.