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Blame for crash?

Blame for crash? The market sell-off has been caused by hedge funds? Some argue, like the IMF chief economist Raghuram Rajan, that incentive fees induce hedge funds into taking more risk and that this is a cause of market volatility. WRONG. It might push long only and non-hedged speculators marketing themselves as "hedge funds" into risky areas but with competent managers, high water marks, their own wealth at risk and incentive fees encourage them into reducing their volatility.

Performance fees incentivize hedge funds to MANAGE risk. They also reward those with the courage to take the other side of long only euphoria. The correction was due to the overconfidence of unhedged funds. Proper hedge funds, if anything, dampen down volatility and market panic. Were it not for hedge funds covering shorts, temporarily underpriced securities the sell off would have been much worse. The performance fee forces managers to be risk averse. Good hedge funds profit from volatility but don't cause it.

Some say incentive fees are unfair because the manager shares in the profits but not in the loses. Wrong again. Real hedge fund managers ALWAYS keep their own money in their fund. A negative year for a hedge fund almost guarantees the defections of key staff and many investors, thereby threatening, often fatally, the fund's franchise. The manager shares in the downside just as much as the upside so the incentive fee acts nothing like the call option payoff profile that many claim. A hedge fund MUST make money every year to be viable as an ongoing business. The upside AND downside is aligned with clients, unlike most investment products where the manager gets paid regardless of performance.

People in glass houses should not through stones. If you want fees for failure and high risk, check out the finances of the IMF itself. IMF chief economists fly first class or in private planes and stay in 5 star hotels as they jet around "helping" poor countries. Incentives are not aligned, they get paid no matter what results from their "advice" or "financial packages". The IMF currently has over 60% of its fund lent to Turkey, a somewhat concentrated portfolio. Turkey has a growing economy and is far from being the poorest or most troubled country.

The IMF also keeps vast gold holdings instead of diversifying its portfolio. It has 2000 economists on its staff yet allocates its funds and own resources abysmally. It is time IMF Chief Economists were paid the same way as hedge fund managers. If their "advice" to client countries works then pay them an incentive salary, if they are wrong then just $1 a day. Seems fair and it gives them a chance to see what living on a $1 a day is like. You won't find that in the ivory tower or textbooks written by poverty "experts".

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