Rich enough for hedge funds?

Rich enough to REDUCE risk? High net worth so ALLOWED to hedge? What is the wealth required by regulators to be "sophisticated" to invest in hedge funds">hedge funds? $1, $1 million or $1 trillion? How to define those lucky few who are permitted to increase returns and lower their portfolio's volatility? Why should those saving for retirement be excluded from talented money managers and diversifying investment strategies? Long only funds alone are unsuitable for risk averse individual investors seeking reliable absolute returns.

The SEC Chairman testified "hedge funds">hedge funds were too risky for Mom and Pop". Really? The evidence is to the contrary. He even wants to increase(!) the net worth to be considered "smart" enough to invest in hedge funds">hedge funds. He should check the FACTS before "protecting" the little guy and attempting to further regulate an industry where the necessary legal protections are ALREADY in place. Fraud has been against the law for centuries. A few hedge funds">hedge funds WILL implode. So? Some airplanes crash so stop letting people fly? Regulators allow people to drive cars but EVERY day we have a national disaster on our roads. Ban cars?

What does "too risky" mean? Harry Markowitz and William Sharpe defined risk as the standard deviation of returns. Stock indices and mutual funds generally have volatilities as high as 20. For most good hedge funds">hedge funds the metric is lower and diversified funds of hedge funds">hedge funds can get under 10. By the academic measure of risk, proper hedge funds">hedge funds are SAFER than the hazardous investment products the SEC currently authorizes! If retail investors should be protected from risk Christopher Cox would urge Mom and Pop INTO hedge funds">hedge funds. Personally I believe in PROPER diversification and for that you need skill-based alpha.

However I don't regard volatility as an informative measure of risk. The Sharpe ratio and the beloved Value at Risk (VaR) based on historical variances are NOT useful. I prefer to define risk as something bad happening and maybe the SEC does too. But again PROPER hedge funds">hedge funds are better with their diverse range of strategies and control of the downside. Surely a 50% drawdown in the S&P 500 is bad? Isn't losing 80% in the Nasdaq very bad? Index funds spending 6 years below last century's high water mark is scandalous? And isn't making absolute returns good? More damage has happened to the traditional part of investors' portfolios than the alternatives part in recent years. Sure, very rarely a poorly managed "hedge fund" might blow up so you need thorough due diligence as with any investment.

Does the SEC mean fraud risk? As the many successful prosecutions prove, financial scams are against the law. The legislation is already sufficient to punish investment fraud and securities law violations. There always will be people around trying to sell questionable stocks, land, bridges and, yes, dodgy hedge funds">hedge funds. Should we therefore stop people buying houses because there have been real estate swindles? Should we ban people from buying cars because of economical-with-the-truth car salesman? Fraud occurs in all business sectors but retail investors should be allowed to buy the hedge funds">hedge funds they need.

Incompetence risk is when there is no intention to steal the money, it just gets lost legally like with Long-Term Capital Management or Amaranth. The SEC permits people to purchase individual stocks despite the fact that some stocks go to zero every year. Common sense and diversification protects portfolios. Nowadays with proper hedge funds">hedge funds there are many checks and balances as well as alignment of interests with investors. The managers' own money should be at stake, professional seed investors conduct ongoing thorough due diligence while fund administrators, prime brokers and other service providers all have a vested interest in avoiding headline risk by checking up on their hedge fund clients.

That incompetent traders and criminals also exist in the hedge fund world does not in any way obfuscate the ESSENTIAL need for every investor, large and small, to put a SUBSTANTIAL portfolio percentage into well managed hedge funds">hedge funds. If the SEC is really worried about RISKY funds sold to the masses it needs to start by looking hard at the products they currently permit and abolishing this accredited investor nonsense.

I know an institutional investor doing a mediocre job of "managing" over a $1 trillion for its pension beneficiaries yet I also know individuals with below average net worth whose financial knowledge is enough to evaluate hedge funds">hedge funds. The naive large investor is allowed to invest in hedge funds">hedge funds but the informed individual is not. Why?

by Veryan Allen. Copyright

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