For the last few years there has been a steady drumbeat out of Wall Street touting the advantages of “alternative” investments for well-to-do investors. The alternative crowd argues that plain old stocks and bonds and mutual funds are no longer good enough for sophisticated investors. Instead, they need a dose of hedge funds, private equity investments, and venture capital deals in order to obtain superior returns and protection from the daily fluctuations of the investment markets.
Hedge funds have garnered the most publicity. They are lightly-regulated investment pools available to high-net-worth investors. Hedge funds use a variety of strategies in an attempt to offer returns that go counter to the public financial markets. If ever an investor wanted a hedge fund to protect them from market fluctuations, it would have been this past summer when the stock market swooned by 10% in a matter of days. Unfortunately, press reports indicate that the most popular hedge funds—those that use computer-driven quantitative strategies to buy and sell securities quickly—were hurt badly in August when many funds sold investments at the same time, driving prices down.
One of the most spectacular blowups came at Goldman Sachs, which enjoys a reputation as one of the world’s premiere money managers for the wealthy. Its flagship Global Alpha hedge fund lost 22.7% in August and 33.4.% in the first eight months of the year. Compare those results to a “plain old” S&P 500 mutual fund, which returned about 5% through August. The Wall Street Journal reported it was “surprising” the hedge fund did so poorly given that its “multi-strategy’ approach allows it flexibility to adapt to changing conditions and invest any way it wants. A letter Goldman sent to its investors cited a litany of missteps, including bad bets on Japanese, Australian, and Canadian currencies, as well as fumbles in the Norwegian and Finnish stock markets. To add insult to injury for the hedge fund’s clients, corporate profits at Goldman itself climbed by 79% for the period June through August.
