Hedge Funds

What is a hedge fund? A hedge fund is really not a mutual fund, but a “private placement” under the Securities Act of 1933…since its exempt from the Securities Act of 1940 (regulating mutual funds). In theory, a hedge fund offsets losses from its equities holdings by “hedging” these losses…by predominantly short-selling. But, in today’s world of well over 6,000 hedge funds, short-selling is used not to hedge, but used as an investment strategy to increase return (only).

A hedge fund can only exist from exemption from the Securities Act of 1940, if the hedge fund follows one of two rulings of exemption under the Securities Act of 1940:

1. Section 3(c)1: This type of hedge fund must have less than 100 accredited investors to exist. Investors must have 5 million is assets or have income of $200,000 for the last two years (and expected to earn $200,000 this year). A 2008 proposal which the SEC is considering is to have investors have additional criteria of at least $2.5 million in investments before being allowed to purchase such a hedge fund.

2. Section 3(c)7: This type of hedge fund can have unlimited number of investors with 5 million is assets or have income of $200,000 for the last two years (and expected to earn $200,000 this year).

Since 1949, hedge funds have caused serious losses (with few profits) to accredited investors. In 1998 a hedge fund was the predominate cause of an 18% loss in the general securities market. In June of 2007, a hedge fund (which primarily invested in mortgage back securities – sub-prime mortgages) was the likely cause of our mortgage crises (and was one of the factors that led to a national recession). And worst of all the government wants or has bailed these hedge funds out…at our expense! In addition, congress has in acted a law to distribute 150 billion in tax credits (I mean handouts) to the general public to help bring us out of the recession…which leads to even a larger national debt (which will take decades of higher taxes to pay-off). Where is the logic in their thinking? Hedge funds should be outlawed! Where is the SEC, when you really need them???  

Hedge funds are the virus that needs to be wiped out before it gets bigger. Hedge funds account for $2.68 trillion in trading activity. That’s accounts for 30% of all fixed income security transactions, 55% of all derivatives trading, 55% of all emerging market bond trades, and 30% of all equity trades. This means the market is not free, but pushed higher or lower based on institutions trying to maintain capital levels in their portfolios, and not the true value which a security is worth or should be traded at. What if your pension owned an S&P 500 stock, that company invested in derivatives and lost 30 billion, and your pension value took a nose dive? Would you be happy? I believe in a free market, but at whose expense?

Let’s go over some other problems with hedge funds:

1. Hedge funds can use short-selling, futures, swaps & other derivatives, and borrow to reinvest. It’s as if they only wish to invest (I mean gamble) at the expense of the investor. If you win 10% of the time in futures market, you’re considered to be great. What about the other 90% of the trades?
2. Hedge funds have a reputation of secrecy, due to keeping their trading strategies secret from their competitors. This means you get no prospectus in most cases. Due to such secrecy, investors cannot determine if the hedge fund is a wise investment choice.
3. You cannot get out of hedge funds (in most cases) until the redemption date. Some hedge funds require two months advance notice of the liquidation.
4. Hedge funds often list their shares on quasi-regulatory exchanges (such as the Irish Stock Exchange)…to lure investors into the investment.
5. Hedge funds borrow from the bank and reinvest into risky investments (such as futures, derivatives, ECT.) Take an example, a hedge funds borrows $9 for every $1 invested, a 10% loss would wipe out 100% of the value of the investors stake in the hedge fund.
6. Hedge funds do not distribute NAV’s daily…or even on a regular basis. So how are you to keep track of your investment performance? Since a hedge fund cannot advertise to the general public…you cannot obtain general information concerning all known hedge funds…to evaluate beta (risk) versus performance.
7. The administrator and the custodian for the hedge fund can be the same company…which can lead to conflicts of interests.
8.  Worst of all, the hedge funds have two types of fees. A management fee from 1% to 5% annually, and performance fee as high as 50% of the unrealized & realized profit. ARE THEY KIDDING??? Performance fee is in the best interests of the hedge fund manager…and not the investor.

Since most hedge funds are established in offshore tax havens, the hedge fund does not pay taxes on gains within the hedge fund. And since most hedge funds are “limited partnerships”…the rich receive favorable tax treatment, while the general public invests in traditional mutual funds and gets “hammered” by the IRS. Why doesn’t congress do something about this problem?

Hedge funds should be against the law. It does not follow the guidelines of the Securities Act of 1940 to protect U.S. citizens from un-lawful investment acts by fund managers & fund companies.

Sincerely,

John Bagwell

The Truth About Financial Products.com

www.thetruthaboutfinancialproducts.com