Article Review of Hedge Clipping
Article Review of Hedge Clipping
The major issue that is being investigated in this article is about risk management as a result of clipping the hedge. Moreover, the article has presented several advantages of hedge funds over other financial institutions such as banks and brokerage companies. That is hedge funds are not regulated by the SEC, and this provides them with a considerable latitude for investing the money of their customers. This article applies the financial data between the years 1996 to 2003 because from the article; it is clear that Malkiel and Atanu examined the data between 1996 and 2003 where he found that the average rate of return for hedge funds was 9.32%. This was less than the average return funds of 13.74% that had been published in the database (Malkiel & Atanu, 2005).
Similarly, the methodology that was used is the identification of skills and frameworks for making a comparison with the managers. For instance, Harry Kat was invited to an interview at the corporate headhunter; a financial company specializes in hedge funds. However, he was given the opportunity but later declined the offer because he thought he is not fit for the job.
According to my understanding, hedge funds are risky investment even though they are associated with riches. Therefore, it is not fit for investment purposes due to the following: the risks that face hedge funds are not linear and more complex as compared to the risks that are facing other financial institutions like banks. Therefore, they are not appreciated widely or well understood. Similarly, hedge funds always use the leverage that is like a two-edged knife. Moreover, they can make the investment on optional securities that can easily lose 100% of their cost. That is they do take the negative side of the securities, and this can have a large appreciation, thus, leading to huge losses as magnified by the leverage. Additionally, the standard deviation does not capture the risk of fund of funds adequately.
Secondly, hedge funds are designed to hedge against the uncontrolled falling of the markets through the application of some complex investment alternatives and strategies. Therefore, the magical derivatives of the hedge funds are not understood properly even by their creators. Consequently, they even blow up in the presence of their creators. Besides being difficult and expensive to accomplish, hedging investments do not make sense in the long run.
According to Malkiel and Atanu (2005), hedge funds are riskier by far. Therefore, it provides lower proceeds than what is commonly supposed. Thus, it is statistically suffering from a severe survivorship with a biased problem (Malkiel & Atanu, 2005). Consequently, the failed funds will go out of the enterprise as their profits will go unreported. Similarly, funds with poor performance, but still exist under no obligation to report their financial reports to any governing body such as SEC. The held assets of the hedge funds are always illiquid in nature. Similarly, the market value of these assets is somehow not visible. Therefore, the moment the value of the assets are uncertain, then the returns will be reported by that fund.
According to Cassidy (2016), at least 80% of the cases after the alpha fee for the hedge funds is negative (Cassidy, 2016). It may not be due to of lack of skills, but the managers do not have adequate skills for making up a two and twenty. Cassidy (2016) further states that about 2% of the assets and 20% of the proceeds is posing a hurdle for the investors to receive adequate experience in hedge funds (Cassidy, 2016). Besides the difficulties in identifying a group of knowledgeable investment managers to overcome the challenges of the extremely rich arrangement of fees, the investor will confront the basic misalignment of interests that is created by pay-off embedded options in most arrangements of hedge fund fees. It implies that investors in fund of funds will find generating risk-adjusted in excess returns to be an impossible mission
Fund of funds (FOF) - Is the strategy of investment that holds the portfolio of other investment funds instead of making direct investment in securities such as bonds, and stocks.
Mystique- This is the power that surrounds someone or something.
Volatile commodities are products with uncertain prices as the value of their security changes.
Findings
Investing in hedge funds is risky in the sense that if someone informs you that he or she experienced a tremendous gain in a certain hedge fund, then the probability is high that the hedge fund managers made some risky affairs that could easily go to the investors in the future. According to this article, the evidence suggests that the views on the nature of the currency market are not necessary for setting policy on hedge fund management especially when the investment alternatives are to fully hedged or unhedged. Therefore, the appropriate policy in investing in hedge funds will rely on factors such as risk aversion, the time frame, and the correlation of the assets in the portfolio. There are some situations when hedging is the best investment method and periods when it is the worst.
References
Cassidy, J. (2016). Hedge Clipping - The New Yorker. The New Yorker. N.p., Retrieved from http://www.newyorker.com/magazine/2007/07/02/hedge-clipping.
Malkiel, B., & Atanu, S. (2005). Risk and Return. Financial Analysis Journal, n. p.
