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Efficient markets?

The more participants in a market the LESS efficient it becomes. Is claiming to make markets more efficient supposed to be a sales point? Hedge funds are beneficial to a portfolio but making the market more efficient is certainly not one of them. Financial markets are traded by humans and by computers programmed by humans. Since humans are irrational, illogical, greedy, fearful and heterogenous, no market can be efficient and no security is ever correctly valued.

Neither hedge funds nor any other investment product increases market efficiency and you would not want them if they did. The market is permanently inefficient and that is a FACT not a hypothesis. Google GOOG at $85 was the wrong price as is where it is today. No-one will ever know what the correct price of Google is or was. Markets are just a fickle daily opinion poll. I have no idea of Google's "value" but I have enjoyed the ride up along with many others.

Hedge funds' correlation to the market in the last 12 months has been 0.80. So what? The "average" is irrelevant and you need a lot more than 12 data points to assess correlation with any confidence; a 100 points minimum in my opinion. Correlation is not a particularly useful statistic; I find cointegration and dependence measures more illuminating. All however are variables, not constants.

The largest hedge fund sector is long/short fundamental stock picking. Often managers are former sell side analysts or mutual fund jockeys and therefore have a congenital long bias. They short a few stocks so they can charge 2 and 20 for their alleged "hedging" skill. Consequently it is not suprising that all these long biased equity hedge funds upwardly skew correlation to the market. They make money when the market goes up and lose it on the way down. Investors need to differentiate between REAL hedge funds and impostors repackaging beta.

Very rarely, money can go amiss in bottom decile hedge funds - the often cited Bayou case for example. Yes mutual fund firms are unlikely to embezzle or implode. Why would they when they can just take your money slowly with their excessive fees and embedded charges for a dinosaur product that fails to manage risk. A "bad" hedge fund month is losing 2%, a bad long only fund month is losing 20%. I know which I would rather suffer as do my clients. You cannot eat relative returns. And why be long in bear markets?

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