There is a well-established sub-atomic physical principle (is it the Heisenberg Principle? the Wittgenstein Principle? Anyway, it is vaguely Teutonic-sounding - your correspondent's scientific days are well behind him) which states that observing anything changes it. Its counterpart in the world of investment is that as soon as a successful technique is widely seen to be successful, it will stop being successful. Alternatively stated, in Hetherington-Gore's Law, as: If you aren't the first, you'll be the last.
Another way of looking at this is to ask why anyone who has invented a successful technique would ever pass it on to friends, let alone people he has never met? It is a reasonable assumption, when you see a book (or a fund, or a stock, or an adviser) offering to let you in on an infallible way of getting rich, that there is something wrong. This can be seen at its clearest in the case of race-horse tipsters. Since information that puts them ahead of the curve will lose its value when imparted to others because their use of it will reduce the odds obtainable from a bookie, any winning system, whether it's based on statistics, inside knowledge or pure form, is long past its sell-by date by the time that it appears on the airport book-shelves.
This is the case at present with hedge funds. At least, it's 95% likely to be the case, although there remains a 5% chance that the bone-headedness of regulators will continue to deprive investors of the choice to invest in hedge funds for a few more years, which will mean that the funds will retain their edge for a while - but not much of an edge.
The year 2000 has seen a bolt for the exit by the hedge-fund supremos; it has seen countless statements by fund managers that too much money is a bad thing in hedge funds; and it has seen equally countless announcements by 'legacy' banks that they will introduce hedge funds to the average investor (any, the 'mass affluent' investor) this year or next year. Armies of lawyers have concoted clever ways of selling hedge funds legally to Mom and Pop investors.
What is going on? It's easy, guys (and gals, all 8% of you according to recent surveys) - the hedge fund is now no more than another popularly-available investment instrument, and it is therefore incapable in the long term of earning more than other such instruments, except by deliberately adopting a riskier investment possibility.
It's important to understand that in the 1980s, the heyday of hedge funds, they were not riskier than plain-vanilla mutual funds - they were just much more successful. Did George Soros take risks? Did Julian Robertson take risks? No, they just played the percentages. At a time when capital controls had not been fully dismantled, when governmemts clung to antiquated ideas of currency control, the existence of an international pool of liquidity bigger than any individual Central Bank's resources meant that almost all bets were winning ones. OK, there were exceptions, but they were few indeed in relation to the successes.
As times changed, and international currency markets became largely fungible on a global basis, the opportunities for such as Soros, along with a small group of immensely rich partners, to move markets began to diminish. That was the time to let in the paying public. Are you sure you want to be the paying public?
The 5% possibility that hedge funds will retain an 'edge', so to speak in a Cockney way, is worth stopping over for a moment. The regulators' insistence on providing only investment products without sharp 'edges has held back the development of international capital markets, and has reduced the returns available to the punters they try to protect. Another law of investment is that the total of gains is determined by the overall balance of economic forces and the economic cycle - it can be divided differently among the players, but the total remains the same. In the 1980s, governments lost big, hedge funds won big, everyone else pottered along on 10%.
The regulators' attempts to prevent 'alternative' investments from being offered to Joe Public are doomed by the Internet, although they (the regulators) only dimly sense this just yet. But they retain enough power to retard the process for long enough that hedge funds (as alternative investments) will continue to deliver a superior return over ordinary (regulated) investments for a while yet. 5 years? 3% more? That's the maximum.
So there is only one question worth asking: what are the next hedge funds?
To be continued . . . but if you have any ideas about this, please contribute them on our Forum at:
See Discussion Forum Topic: Alternative Investments - add a comment to the InvestorsOffshore Discussion forum
It will only be seen by 20,000 people (not enough to change anything - we're not the Wall Street Journal!)
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