|
Gravy Train Stop
|
4 October 2004
|
JPMorgan Study Says Hedge Funds Must Change Strategies
Just as it is about to buy hedge fund Highbridge Capital Management, a hedge fund, JPMorgan has issued a report that says the fat returns earned by hedge funds will peter out unless they change their strategies. What JPMorgan wants is for hedge funds to focus on inefficient markets where they can profit from inefficiency -- which is what every speculator tries to do.
The market mechanism has rising and falling prices because of imperfect market conditions. If market participants had perfect knowledge concerning a homogeneous product, and if those participants had no barriers to entering or leaving the market, and if they were numerous enough, prices would never change. As reality varies from those conditions, inefficiencies arise that cause prices to fluctuate. It is on fluctuating prices is what hedge funds and other speculators and investors thrive.
The JPMorgan report says of hedge funds, “ . . .as they grow larger, they will eventually erode the market opportunities and mispricings they have relied on to create their superior returns.” The report says the hedge funds should focus on bonds, forex trading and some parts of the equity markets.
What the report doesn’t address in any detail, but which John Plender of the Financial Times noted, is the fee structure of the hedge funds. This is the reason JPMorgan and others are going to buy up some of the funds. The average hedge fund gets a 2% annual payment plus 20% of the profits. They don’t participate in any losses they book. And since most hedge fund managers, according to Mr. Plender, are “little more than momentum traders,” this is a “wonderful racket to be in on.” Add in the “fund of hedge funds” approach (wherein investors get to pay the 2% and 20% twice), and the racket sparkles even more.
There are also some very fine fund managers, as Mr. Plender attests, but the real key for the hedge fund success is operating where markets aren’t very efficient and using their expertise and legal dispensations to profit from the inefficiencies they find. And as they work their magic, they will improve market efficiency. This will make it harder and harder for momentum traders to profit -- and investors will wise up to the huge fees they pay. Another Wall Street fad will then pass, and the few good ones will continue to earn a more-than-decent living.
© Copyright 2004 by
The Kensington Review, J. Myhre, Editor. No part of this publication may be reproduced without
written consent.
Home