Thursday, March 05, 2009

In Defense of Hedge Funds

In the wake of hedge fund losses and several outright scandals, there is understandable concern about the industry. I'm sure that we'll see increased regulation and oversight going forward, we'll see less leverage, and we'll see better due diligence on the parts of investors (and maximum transparency from funds themselves).

The financial industry itself, however, has become a poster child of greed and a whipping boy in the recent crisis. To be sure, the AAA securitization of dodgy home loans has its share of culprits among investment banks, ratings agencies, regulators, congresspeople, and government-sponsored enterprises.

Hedge funds, however, make for particular targets as--one recent article put it--"legal scams" in which "investors pay through the nose for something that isn't what it's cracked up to be". Forget the fact that the article simultaneously blames funds for not protecting investors on the downside *and* for causing the market decline with its short selling. The major thrust of the article is that this is not a legitimate industry; that it's a vehicle for greed, pure and simple.

I work with hedge funds and, as a psychologist/coach, I get to know the management and portfolio managers personally. The ones I have worked with have responsible risk policies, feel a strong commitment to investors, and indeed invest heavily in their own funds. When investor money was plentiful, they expanded their markets and strategies and, in some cases, got caught in markets that rapidly lost liquidity and value. Even so, they have held the downside well and, for the most part, are making money in 2009 with relatively plain vanilla strategies and modest risk levels.

I am confident that there will be a hedge fund industry in the future, though the shakeout has been and will be severe. Those firms that survive will be ones that managed risk well through this period of volatility and reduced liquidity, offering consistent risk-adjusted returns and superior transparency for investors. These firms eat their own cooking; the life savings and careers of the partners and portfolio managers are on the line. I see the concern for markets and investors in their conversations, and I see their responsible commitments in their policies and management.

No one asked me to write this, but it needed to be said: not all hedge funds are scandals or dens of greed and vice. I have years of work with portfolio managers and senior management that shows me otherwise. The entrepreneurial spirit they embody--not any bailing out of failed business models and organizations--will be what lifts the American economy from its weakened condition, as it has always been a driver of growth, innovation, and prosperity.

Brett Steenbarger