Getting Real with Hedge Fund Regulation

For the Government to get in the ring and try to further regulate hedge funds would be like me trying to referee a Cricket game. I could probably go in there and just assume this or that is right or wrong, but I’d be interfering with the game, with the competition. And just as in Cricket, that is how the free market operates. Sometimes you win, sometimes you lose, but you’ll never be punished by the Ref changing the rules in the middle of the game.

Ok so here’s the deal:

Hedge Funds, PE, and other alternative investment pools SHOULD NOT be subject to increased public regulation and disclosure requirements, especially now that the minimum requirements for investment in these funds has increased. The main concern raised by politicians and other would-be intervention artists seems to be the risk exposure these funds bring to public capital, namely in the form of pension and endowments, both of which have been and continue to be major investors in these funds.

Assuming this is the true reason these politicos are pushing for increased regulation, to me, is absolutely ridiculous. If the real concern is that public pension, etc money is exposed to “risky” investments such as hedge funds, than the obvious conclusion is that the pension and endowments themselves should be limited in the amount (or more accurately proportion) of their capital they allocate to such investments. Such an approach precisely attacks the apparent problem (to what extent alternative investments are any more/less risky than any other class is beyond the scope of this post), and is in-line with the free market philosophy implicit to functional and efficient markets.

Generally speaking, do I believe that hedge funds should be further regulated? Not necessarily. While assets in hedge funds and other alternative investments has reached incredible highs, and the number of failed hedge funds continues to increase, I don’t believe that increasing the regulatory burden on these funds will have any meaningful positive impact on the economy, their investors, or any other significant constituency (besides maybe self-serving government types perhaps). If an investor, whether individual or institutional decides to invest in a particular asset, in this case hedge funds, the critical fact to remember is caveat emptor, buyer beware. Just as with investing in any asset, solid diligence should be conducted, and a portfolio should be sufficiently diversified according to the investment vehicle’s/individual’s risk profile. Right now, there is a staggering amount of money searching market-beating returns, and I believe that some otherwise intelligent managers and investors have been increasingly jumping into investments without their usual diligence and caution. In such a scenario, you can’t feel sorry for sophisticated investors getting the short end of the stick because of their short-sightedness.

I can’t stress enough the fact that investors need to be vigilant when investing in hedge funds. Ask questions. Demand transparency and accountability. (Some) hedge funds take on substantial amounts of risk. Uncooperative management simply won’t help the matter, and could even be taken as a sign that the investment strategy(ies) employed wouldn’t stand up to scrutiny if they were shared with investors.

The fact of the matter is, that it is up to investors to manage their risk, not the government. Blowups, crashes, and unexpected events happen, but with a well-diversified portfolio and other risk-management techniques, investors in hedge funds and other alternative assets do not need the government to get involved, at least not by regulating the funds themselves. If public money is the concern, restrict the public pension/endowment pools, attack the problem at its source. End of story.