Sunday, March 23, 2008

Effect of Hedge Funds Today

As the hedge fund industry continues to grow, the markets have turned increasingly volatile today. This logically hurts the less-informed retail investors as it forces more price instability related risks onto their positions even in bullish periods.

Growth of Hedge Funds

Presently, the hedge fund industry exceeds $1 trillion, and still expanding as money managers attempt to squeeze every drop from the apparently saturated market. The investment vehicles utilized range from equity, commodities, debt instruments, to derivatives of all forms. Some make directional or market neutral bets while others attempt arbitrage. Nevertheless, the relative large sums create significant price impacts with each order.

Increased Risks for Public Investors

Prices move as a result of relatively large initiated orders, and the hedge fund industry does just that. This evermore evident phenomenon hurts the uninformed investors as it leaves them literally “buying at tops and selling at bottoms”, due to a lack or delay of information.

Wall Street rumors and news releases tend to reach fund managers first, where the public usually stands last in line. This creates unfounded risks in present industry condition as the price affecting hedge funds have first dibs on most relevant information, and they usually take action before the mainstream crowd to preserve or amplify returns.

Volatility from Hedge Fund Sentiment

With so much more capital influenced today, vague rumors or corporate press releases all potentially trigger backbreaking ripples across these secretive investment pools. Collective fund management sentiment has created unprecedented power in the industry, as seen in the present liquidity issues faced by “prime” mortgage backed investment vehicles.

Back in 1998, a quasi-recession resulted from the fall of Long Term Capital Management, a hedge fund run by two Nobel Prize winners. Their failure, a loss of “only” $4.6 billion, had caused such market turmoil that many individual investors had lost fortunes, some everything.

When ratings agencies downgraded General Motors debt to junk bond status in May of 2005, the shock throughout the hedge fund industry caused a steep correction in the major indexes. Only after awareness of GM solvency, along with heavy buying from the public, did this near-catastrophe go unnoticed.

Solutions for Individual Investors

Without an edge, statistical or information regarded, the uneducated investors face sharp negative expectancies in the present financial environment. The solution requires a bit more work than ever before, like any other business. Do the researches, study how the hedge funds and Wall Street institutions function, learn the math, become informed. When it comes down to it, follow the money and you will not mind the work.

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