Michael Corleone: Just when I thought that I was out they pull me back in.

The Godfather: Part III

Like Michael Corleone we feel “pulled back” to our hedge fund coverage. For some time we had felt like we had neglecting the hedge fund side of the alternative investment world in favor of private equity. Given the news flow out of private equity it should not be all that surprising. However a flurry of items has refocused our attention on hedge funds.

Adam Shell in the USA Today has a somewhat skeptical take on the world of hedge funds. Shell contrasts the recent poor performance of hedge funds with their growing asset base. By one measure 20% of hedge funds are down year-to-date. The belief is that hedge fund marketing is still being driven by their strong relative performance during the downside of the Internet bubble. If that is the case what will another mediocre year of returns do to investor confidence.

“There is the myth of the manager, that all of these great returns are driven by the unique skill of the managers,” says Schneeweis of the University of Massachusetts.

Hedge funds, it turns out, may not mint money after all. “Investors will start asking themselves, ‘If I am going to lose money in down markets, why bother investing in hedge funds?’ ” says Michael Schlachter, managing director at Wilshire Associates.

This raises an issue we touched on in an earlier post on the concept of “synthetic” hedge fund returns. Research seems to show that using a handful of exchange traded instruments a manager can synthetically capture the systematic returns to a hedge fund index without the exorbitant costs of actually investing in illiquid funds.

We would tend to disagree with a point made by Alpha Male at the fine blog All About Alpha on the motivation of investors in hedge funds.

The truth is that institutional investors don’t invest in hedge funds because they “desperately need high returns”. They invest because they are tired of riding a roller coaster each year.

It seems that as the hedge fund industry grows returns are becoming more “market-like.” If that is the case, aren’t there easier ways to generate more stable returns without having to pay individual hedge funds 2 & 20 in addition to the due diligence costs inherent in direct investment and/or the fees of a hedge fund of funds manager? Just asking.

While we are generally more interested in discussing the macro situation in hedge fund land a big hedge fund blowup always moves the needle of the mainstream media. Ann Davis in the Wall Street Journal has an in-depth report on how the main energy trader at at Amaranth Advisors was felled by the volatility of the natural gas market that had once been so profitable to the firm.

Gretchen Morgenson and Jenny Anderson at the New York Times focus on the potential fallout that the failure of a string of large, leveraged hedge funds, like Amaranth, could have on the financial markets. They note some prior discussions by regulators that at the very least they needed additional information on the positions and leverage that hedge funds hold.

The Amaranth blow-up brings to mind another famous blow-up, LTCM to Joe Weisenthal at The Stalwart. Weisenthal notes the differences between and two and why hedge funds might be attractive vehicles to the oh so rich.

Moving from Amaranth to other big name hedge funds, Roger Ehrenberg at Information Arbitrage wonders whether Steve Cohen of SAC Capital, despite a recent Wall Street Journal profile, may still be holding his cards close to his vest.

Another big-time hedge fund manager with a penchant for secrecy is Edward Lampert of ESL Investment and Sears Holding (SHLD) fame. Gregory Zuckerman in the Wall Street Journal reports on growing speculation that Lampert is poised to acquire yet another large cap target.

Lest you think the world of hedge funds hasn’t changed one need only read this post by John Carney at DealBreaker.com. Not only does Carney note the growing intersection of hedge funds and politics, but he also has excellent taste in his movie references.

The world of hedge funds is nothing if not dynamic. It will be interesting to see if this most recent turmoil has any effect on the plans of one (or more) hedge funds to take themselves public. Stay tuned.

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