The Dangerous World of Hedge Funds

Marc Lasry buys the debt of troubled companies.  Before he does, though, the fifty-one-year-old hedge fund CEO and Milwaukee Bucks co-owner takes into account everything that can go wrong. He wants to know the very worst that can happen. As he stresses in Katherine Burton’s book Hedge Hunters, “I don’t want to hear how great the investment is.  I want to hear how we can get hurt. Once we know our downside is protected, then we look at what we can make on it.”

This, in a nutshell, is one man’s contrarian approach to building a hedge fund.  The driven former bankruptcy attorney started Avenue Capital Group in 1995.  By 2001, assets totaled one billion. By 2007 he’d built the fund to $14.5 billion.

But clearly Avenue ’s also seen some bearish activity along the way; according to the firm’s website its current assets amount to just short of twelve billion dollars. If it seems to you this is a wild way for an individual to invest his money, think about this: institutions including state pension funds pay billions into Avenue Capital Group, and pay Lasry two percent of assets and twenty percent of any profit he makes. Oh, by the way – Lasry’s performance bonus is not based on the highest returns, but rather “for having a steady performance.”  How comforting that is to the millions of Americans whose pensions depend to some extent on hedge fund managers is an open question.

Then you have Craig Effron, whose $3.25 billion hedge fund, Scroggin Capital Management, “[B]uys and sells the stocks and bonds primarily of companies that are merging, spinning off units, or going through financially tough times.” After abandoning plans for law school, and a short stint at E.F. Hutton, a friend invited Effron to watch him trade commodities on the New York Mercantile Exchange.  “It’s a football game,” his friend told Effron. “You’re standing with a bunch of very big guys, all pushing and shoving.  It’s very Darwinian. It’s the purest form of capitalism I know.”

Are we having fun yet? Such is the day-to-day pace of hedge funds.  It’s a fast-moving world that’s not for the faint of heart – but instead for the investor who has to prove to himself he can lose big first in order to win big.  Here you must realize I use the word “investor” with a degree of irony. “Gambler” is closer to the mark.  Except he’s not gambling with his own cash, but yours.

While hedge funds are reserved for more affluent (or accredited) individuals, they also count among their investors funds, like pension funds, that may have billions as a whole, but represent the retirement needs and dreams of millions of middle- or lower-income individuals like you and me.  Nevertheless, they are for the most part unregulated by the SEC.  So if you do decide to go ahead and pump money into a hedge fund, good luck.  You just might fare better at the race track.  You’ll know where you stand sooner – plus the air’s fresher.

You’ve worked hard for your money.  If you want to see your nest egg grow, don’t bet the proceeds in a glorified dice game where you’re not even the one holding the dice.  Despite what you see in movies and on cable financial entertainment channels, economist Paul Samuelson has it right when he says, “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”

You don’t want drama, you want security and certainty.  You want to know your retirement funds will be there when you need them, not blown in some multi-millionaire’s testosterone-fueled dice fling.

Tomorrow: With sky-high fees and poor performance, guess which mega-player said this week they’re dumping their hedge funds…