Getting the Economics of Hedge Funds Right

Some of the loudest commentaries over this year have concentrated on the large bonuses that Wall Street firms distributed among their associates and partners as rewards for successful trading performance in the previous year. Granted that these rewards represented enormous sums of money,this blogger remains unconvinced that there is particular reason for concern about such high incomes.

However, anyone who bears a genuine interest about professionals who earn huge sums of money ought to review the reported incomes of hedge fund managers. This extremely informative feature in the New York Magazine takes readers through the distinguishing features for hedge funds, the psychological make up of the more recognized hedge fund managers and the genesis and reasons for the momentous growth of the industry.

It turns out that most hedge fund managers not only have peculiar views about investment, but that the industry seems to be built on the assumption of perpetually high returns.The typical fees structure is based on the 2 & 20 principle wherein the fund shaves off 2% for annual management fees and 20% of the absolute profits. The rise in the number of hedge funds leads to the question about the degree to which grand lessons from LTCM's collapse are relevant at all. With the proliferation of hedge funds and the superstar founders, the likelihood of a perfect storm are ever higher. As John Kay reckons, the extreme confidence in the ability of models employed by this category of investors are such that such returns cannot be guaranteed. Any model is as weak as the assumptions built into it in addition to the failure of the model itself.