Financial Reference

My wife set up this blog/website for me. I would like to think it was because she loves me. Not that she doesn’t love me, but more and more I think she did it so I could annoy someone else with my financial rants. I’m sure it was much less work — not to mention less annoying and stressful.

Currently, I am in the beginning stages of starting an investment partnership. (Legally, it would be formed as a hedge fund but would have little hedging, leverage, or trading and much lower fees.) It is easier to think of it as an investment partnership or, if you will, a mutual fund that uses some leverage and is not diversified.

Knowing this, my wife found me the perfect article: How to Build Your Own Hedge Fund. My first clue that this might not be helpful was that it was written for BusinessWeek. I have nothing against reading BusinessWeek — you’ll learn a little more than watching a Bowl Game on mute (what I’m currently doing).

I soon realized that the article was not about building your own hedge fund but about hedging your annual bets by using long and short mutual funds. And if you would have used the best performing long and short mutual funds you could have hedged your bets (annually) and performed very well over the last five years.

The salespitch goes like this: by going long and short you are taking out the effect of the market. Sounds like a good thing. No more wild swings year to year. Own stocks but have a risk profile closer to bonds or t-bills! It’s a great sales pitch. An increasingly popular sales pitch. See, for example, my local paper’s (Milwaukee Journal Sentinal) treatment of this new product.

The problem with the product is that it takes an investor’s best friend out and replaces it with his worst. Over time, the best results come from having a positive exposure to the stock market. The market has returned 10-11% annually although many bears fear the best days are behind us and we will only see 6-8% returns. Even at only 6-8%, that’s a tough tide to bet against. The product takes out the positive effect of the market.

In addition, the product gives the investor more exposure to a stock-picker. A stock-picker who works for a mutual fund. In the past, mutual funds have underperformed the market! The investor is substituting the source of most gains with a source of losses.

The investor would be much better off buying index funds and exchange traded funds (etf) and letting the market take you on a more wild but more lucrative ride.

And now I feel better — I got in my two cents and my wife doesn’t have to pretend to listen to me.