It seems to me that to be good in the investment business you just can’t think straight. Thinking straight will get you in trouble every time. Now I didn’t say think smart, I said think straight. Thinking straight to me means thinking in a straight line. Let me give you an example. My business partner and I took a flight to New York just two weeks after the Sept. 11th World Trade Center disaster. It was a very surreal day. As we approached New York City, it was impossible to avoid noticing the fighter jets escorting us to LaGuardia Airport. As we got closer to the airport, I noticed military helicopters patrolling the river. The straight line thought process would be to think exactly what I heard the man behind me say. He said, “This is a pretty stupid time to fly into New York.” My business partner looked at me and said, “This has to be one of the safest times ever to fly into New York.”
Exactly. If you think about it there have been very few times when it would have been safer to fly into New York. We had a safe plane on a safe airline. We had a military escort to the runway. It was very unlikely that terrorists would have put together two attack plans of that magnitude back to back. And if they did, passengers would have acted differently with potentially different outcomes. Any way you look at it, we were safer than I had been just a few weeks earlier when I last flew to New York. The mere fact that we were aware of the potential danger made us safer. But there was no doubt that we felt the inherent risk much more deeply on that trip. The reminders were everywhere that flying can be hazardous to your health.
I think that we have a lot of reminders that investing can be hazardous to your health. The losses are still fresh and the government has once again called in the troops to protect us from what has just happened. We have needed a financial reform package for years, but it just didn’t seem that important when everyone was making money. I mean, who cares if your investment vehicle is hiding a lot of its fees in places you will never find and taking much more out of your return than you realize? As long as the investor is making good money, everyone can just look the other way.
That has rarely been more evident than in the hedge fund industry. For so long hedge funds just weren’t available for the average investor. That, of course, made them even more desirable. And for years the hedge fund industry has been able to keep their “trading secrets” hidden from regulators by claiming that if they disclosed how they did things, they would lose their advantage. Now we have found that some of them had the advantage of just lying to their clients about their actual returns, creating a shadow of doubt over the entire group. The final blow came to the hedge fund industry when the financial markets began the second worse crash in history at the end of 2007. By Sept. 2008, we were in the middle of a full blown credit crisis. The one thing most investors expect in a full-blown crash is for their hedge funds to step up and make things ok. That didn’t happen. They were a hedge if you consider the Hedge Fund Index was down less than 30 percent in 2008 and the stock market was down even more. But still it is hard to feel as if you were really protected when your insurance was down 27 percent.
So, here we have an industry that has had a very rough couple of years. It has been the victim of graft, corruption and bad markets. And because of this loss of faith, many hedge funds have opened their doors to smaller investors trying to attract money back to the table. It seems to me that this would be a pretty good time to consider whether hedge funds would be an appropriate investment for you. They have probably never been under more scrutiny than now and the investing world is suspect. What’s more, it appears that the markets will be volatile for a while and hedge funds normally have success dampening the negative effects of a volatile marketplace.
So why would you look at hedging your portfolio right now? I guess because it just feels wrong and that’s usually a good sign.
Scott Reed, CIMA, AIFA, is CEO of Hardy Reed Capital Advisors in Tupelo.