Is the hedge fund industry doomed?

The indictment of SAC Capital and administrative action against its founder, Steven Cohen sure could make you think that. Cohen’s company is accused of systematically using inside information to defraud the markets, and Cohen is charged with failing to supervise them. If the charges are proven, SAC is out of business, most of Cohen’s wealth is confiscated, and he will never manage money again.

But Cohen’s firm was unique. It isn’t really an investment firm, it’s a trading firm. It employs some 400 traders who make thousands of short-term bets, both long and short, on how large, liquid stocks will do. For the privilege of putting money with SAC, investors pay 3% of their assets and 50% of their profits. Cohen himself invests money with his most profitable traders.

The structure of Cohen’s firm encouraged traders to set up expert networks of well-connected individuals who could tip them off to pending news. It rewarded them for getting as close to the line as possible without crossing it. Most hedge funds don’t do this. They arbitrage announced mergers, or convertible bonds, or speculate on corporate turnarounds (or not), or go long one company and go short a competitor. Some strategies have worked, while others have failed.

Hedge funds exist because hope of massive outperformance springs eternal, and some funds have been massively successful. (Although their massive fees make such outperformance unlikely.) As long as that hope remains, the industry will as well.

Douglas R. Tengdin, CFA

Chief Investment Officer

Leave a Reply

Your email address will not be published. Required fields are marked *