Back The Bros Against The Hedgies

As for their analytical capabilities, this is not a difficulty these days. There are currently over 167,000 holders of the “Chartered Financial Analyst” qualification, whose ability to analyze financial and market situations is equivalent to that of all but a very few employees of hedge funds. There are also MBA graduates and professional mathematicians lacking the CFA qualification who can do an equivalent job. If they are of the Millennial generation, the CFAs, MBAs, and mathematicians will also be at least as tech-savvy as the “professionals.” The days when retail investors were all “little old ladies” to be fleeced are long gone.

There is an overall macroeconomic problem with hedge funds. At least in principle, they are set up to exploit short-term pricing anomalies in stock, bond, and other markets, using leverage to turn modest profits into exciting ones. This is an economically valuable activity, and funds to do this have existed since at least the 1960s, although in normal markets there is a periodic weeding out of those that take excessive risk.

However, in the years since 1995 when interest rates have been held artificially low and liquidity artificially high by a Gosplan-like Federal Reserve, hedge funds have proliferated. At first, they achieved high returns; the cost of their leverage was held down artificially so that transactions that would have been inadequately profitable with a normal cost of leverage became extravagantly profitable. However, as time went on those high returns were arbitraged away by the entry of new hedge funds, attracted both by the initially superior returns and by the ease of raising capital from dozy pension funds and college endowments (we’re looking at YOU, Harvard!) Thus, in today’s market, there is far too much money chasing a limited volume of profitable opportunities in the hedge fund space. As a result, hedge fund returns have generally crashed, far below those of the market as a whole.

There are however other reasons why hedge funds can be expected to have poor returns. One is the pervasive office politics in the organizations, full of aggressive ambitious people with few scruples standing in the way of their personal success. If it is socially fashionable to believe in left-wing “cancel culture” and extreme environmentalism, particularly on the climate change issue, that is what the young hedge funders will believe in. Too much money from the hedge funds will then surge into investments that tick those boxes; the price of those investments will be driven up and their potential returns down, even if the environmentally desirable investments are intrinsically economically viable, which most are not.

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(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of "sell" recommendations put ...

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