November 07, 2024
Editorial

HEDGES AND STINGS

A glowing description on the Internet of something called Guaranteed Returns Diversified Inc. says that it can accept only 17 more investors in its newest hedge fund. It predicts a return of 22 percent for the first three months and at least 32 percent later on. It claims that it will “seek out unconventional investment strategies” and that “all moneys will be safely held in offshore tax havens.”

Too good to be true? Well, yes. Click on the “ACT NOW” button and you will get the U.S. Securities and Exchange Commission saying, “If you responded to an investment idea like this, you could get scammed.”

The SEC’s operation doubtless saves some suckers from biting. But the Internet is full of genuine come-ons, in a mushrooming hedge-fund market that has begun to go after investors with modest incomes instead of just multimillionaires. While many funds are honest enough, some are Ponzi schemes that funnel back new investors’ money to provide huge returns – until the fraud collapses.

One site offers biotech hedge funds as “The Billionaires’ Secret: The world’s #1 investment vehicle makes money whether the market goes up or down … (Yet 98 percent of investors don’t have a clue).” The breathless announcement boasts of one fund that “rose 423.6 percent over the past few years, while the S&P 500 has gone nowhere” and another’s “665.2 percent return over the same period.”

Those spectacular earnings, if true, came in the 1980s and early 1990s. Claims of merely 8 to 10 percent are more usual now, after thousands of new hedge funds have entered the picture and after several spectacular crashes.

Hedge funds have voluntarily accepted investments only from extremely wealthy individuals and from organizations like retirement plans and university endowments, starting at $l million or more. They pool the money and invest it in various instruments such as “derivatives” like pools of mortgages. Many of them use leverage by investing borrowed money. Most hedge funds charge annual fees of 1 to 2 percent of money invested, plus 20 percent of any profit earned.

Unlike mutual funds, they have mostly escaped government regulation until recently. Starting Feb. l, the SEC has required managers of large funds to register as investment advisers, but it admits that its oversight is limited.

Funds made up of hedge funds, rather than individual securities, are attracting more modest customers with entry minimums of $25,000 or even as low as $10,000.

State regulators who spoke at a recent forum on hedge funds in New York City warned that individual investors have a hard time learning facts about the background of fund managers, their investment strategies, the nature of the underlying investments and the risks involved. One regulator told of an organization that sent three people to California to interview a fund manager – one to ask questions, another to write down the answers, and the third to record facial expressions. Most individual investors couldn’t afford that.

So don’t be dazzled by get-rich-quick promotions. And remember that high prospective earnings mean high risks.


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