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    Hedge Fund Myths Debunked

    By Stock Charts | May 26, 2007




    I came across a interesting article over at Crestmont Research on common hedge fund myths. I’ll admit that I’ve believed a few of these myself, but the author seems to do a decent job of busting the myths. Take a look:

    MYTH #1: POOR PERFORMANCE

    One of the most prevalent myths relates to the performance of hedge funds—that they generally don’t make enough returns. This myth has two elements: wrong conclusion and wrong benchmark. When markets are down, hedge funds often underperform the often-supposed benchmark of 10% returns. When markets are up, hedge funds often underperform the market. Therefore, so the myth goes, if hedge funds are always underperforming, then they must be poor investments.

    MYTH #2: FAILURE RATE

    The conventional wisdom is that 10-20% of hedge funds fail each year—quite a blow-up risk for hedge fund investors.

    MYTH #3: TAX INEFFICIENT

    Almost universally, outsiders to the industry think that hedge funds are not tax efficient since they supposedly trade actively—all of the income must be either short-term gains or interest income.

    MYTH #4: SURVIVORSHIP BIAS

    This myth implies that the hedge fund indexes reflect artificially high returns since they often do not include the poor performance of the funds that have moved to the graveyard. As a result, the myth-sayers state that actual hedge fund returns are generally 2% to 4% lower than the reported indexes.

    MYTH #5: HIGH LEVERAGE

    Supposedly, hedge funds use high levels of leverage to amplify returns.

    MYTH #6: SPECULATIVE

    Hedge funds are often believed to be speculative investors that take high risks to seek returns that are greater than the stock market.

    MYTH #7: EASY TO START A FUND

    Outsiders often quip: “Anyone can start a hedge fund…and they’re all doing it!”

    MYTH #8: HIGH FEES

    This ‘penny-wise and pound-foolish’ myth asserts that the high fees at hedge funds prevent them from delivering satisfactory returns.

    MYTH #9: HIGH-WATER MARK CLOSURES

    If a hedge fund loses money, then supposedly the manager will just close the fund and start over to eliminate the need to make up losses before getting new performance fees.

    MYTH #10: LOW TRANSPARENCY

    Critics cry that hedge funds should be avoided because they are not required to disclosure their holdings and investors have no way of knowing what the fund is doing.

    MYTH #11: SOURCE OF RETURN

    Most of the returns from hedge funds are driven by the trends in various financial markets; investors receive little skill for their excessive fees. Often this myth appears, for example, when critics say that hedge fund returns include a lot of general stock market return (so-called ‘beta’).

    MYTH #12: LONG LOCK-UP PERIODS

    Another criticism relates to the provision in most hedge funds that requires investors to stay invested for a year or longer, so-called “lock-ups.” Some believers of this myth say that investors should demand an illiquidity premium, or avoid hedge funds entirely.

    MYTH #13: TOO MANY FUNDS

    There are now more hedge funds than listed stocks. With so many funds, the critics claim that there must be limited opportunities for future profits.

    MYTH #14: HEDGE FUNDS ARE NOT REGULATED

    Hedge funds often are said to be unregulated or lightly regulated. The perception is that hedge funds are cowboys taking advantage of the wild-west financial markets without a sheriff in town.

    MYTH #15: HEDGE FUNDS ARE FAST TRADERS

    Hedge funds are believed to be active traders, constantly slinging stocks in and out of their portfolios.

    Visit Crestmont Research for the full article with the evidence debunking these myths.

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