Do we need Hedge Funds?

Discussion in 'Politics, Religion, Social Issues' started by senseless, May 9, 2010.

  1. senseless macrumors 68000

    senseless

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    #1
    "Hedge Funds" pop up a lot whenever there's market turmoil. Are these operators causing volatility by capitalizing on other people's misery or do they perform a vital market function?
     
  2. Decrepit macrumors 65816

    Decrepit

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    #2
    A properly designed hedge fund can make a ton of money with limited downside.

    Most of the turmoil we've seen has been fraud based. Organizations that are paid to watch those that pay them. And therefore never see any problems.

    Every one of these people you see on TV that say "nobody could have seen this coming" are lying every bit as much as those after September 11th that said nobody ever saw that coming.

    When you remove regulation, or remove it by defunding it, you create opportunities. I've seen interviews that were discussing how the Mafia and similar organizations were designing some of the laws, or regulations since they could build in the loopholes up front.
     
  3. GfPQqmcRKUvP macrumors 68040

    GfPQqmcRKUvP

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    If you ban hedge funds you are essentially just banning investment. They're investors with a larger than average amount of money contributed by wealthy individuals and other investors (think pension funds, endowments, etc). I don't really know how you can ban them. Are some of their tactics ill advised at certain points in time? Ya, probably, but the way I see it, their role is no different than anyone else trying to make some money in the market. In doing so they're increasing liquidity and encouraging accurate capital allocation. In the end, it comes down to what you want to hear. Do you want a scape goat or a full picture of what's going on? There are some that think hedge funds and other firms ruined Greece in their "speculation" in CDS's (even finance ministers are susceptible to this, although I suppose that's mainly political) or you realize that Greece's problems preceded super high CDS volumes and that the situation was brought on by actual worry over the fiscal situation of Greece and, later, of the unity of eurozone countries. I know, not the most organized post, but I'm busy and on my iPad. Not exactly the winning combination.
     
  4. rhsgolfer33 macrumors 6502a

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    #4
    I don't have a problem with hedge funds. If wealthy individuals want to take greater than average risks with their money in search of greater returns, far be it form me to stop them.

    I also think that short sellers play an important role in price determination and see nothing wrong with the practice.

    I also tend to agree with Badandy that people and politicians tend to look for a convenient scapegoat for what actually is the root of the problem.
     
  5. callmemike20 macrumors 6502a

    callmemike20

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    Hedge funds are mutual funds on steroids. They aren't bad. They are just simply another way to invest.

    I think the main problem comes from derivatives (well, I don't think they are a problem, but others do). Derivatives are hard to explain, but, in short, they are bets on the future. Hedge funds deal with derivatives, which could be the reason to hear about them a lot. Options and shorts are types of derivatives. They can be simple, but they can also grow to a complexity that no one can understand.

    In my opinion, derivatives are necessary to keep the market moving. They are simply a way to hedge (reduce) risk. If a bank can reduce its risk to the markets by shorting the Euro or holding options in a specific stock, then the market will not fall as bad during a bad time.

    For instance, let's say you have $100 you want to invest. You have 2 choices:

    1) Buy 1 share of company A for $100.00/share
    2) Buy an option contract for $10 to buy 1 share of company A at $91 1 year from now.

    In either situation, you want to make a return on investment.

    If you go with option 1, you will have $100 worth of stock in company A. In 1 year, if the stock price drops to $75, you lose $25. However, if it goes to $120, then you make $20.

    If you chose option 2, you will have the option to buy 1 at $91 per share in one year. So, if the price is $120 in one year, you buy 1 share for $91, then sell it right away for a $19 profit ($120 stock price - $10 contract - $91 purchase price). However, if the stock price drops to $75, you only lose $10 becuase you don't have to exercise the option. Thus, you are less exposed to risk.

    These bets on the future can save a company and an economy a lot of money. However, the recession and the stuff happening at Goldman (which isn't really an issue about derivatives, but rather an issue about ethics) are causing an uproar in politics and giving derivatives a bad name.
     
  6. pilotError macrumors 68020

    pilotError

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    #6
    Hedge funds aren't all that different than your mutual fund/larger brokerage company. In short, any trader that brings liquidity (cash/stock) is good for the market.

    The big difference is that Hedge funds are active traders, meaning they buy and sell on a daily basis and may take positions in stocks that a mutual fund or brokerage wouldn't take on.

    If your in a major brokerage, they typically take a buy and hold strategy. In this market, its hard to do that, and is a dying strategy for the most part.

    As far as policing the hedge funds, its not really all that true (paid watchdogs). If these funds were screwing people on a regular basis, you can bet your a$$ there would be someone all over it. They also tend not to screw other traders, as that will only get you locked out of the market. So in a way, its a self correcting system.

    There are scammers, and some of them have gotten caught. Madoff being a big one, and mainly due to the fact that everyone on the street knew him and trusted him. The scams were pretty extensive, involving lawyers, accountants, programmers, etc., to cover their actions. It's a pretty rare thing to have happen, but it does happen.

    These scam outfits are usually blackballed (the pump and dump and boiler room scammers) from trading through normal venues. With electronic trading, its harder to know who's on the other side, but the bigger shops usually avoid it, because they tend to prey on the smaller stocks.

    As far as Options, everyone uses them and they are an excellent strategy for CYA on the downside. If you play it right, you can get make money on both ends (stock and option). Options are also not buy and hold. It's perfectly valid to sell them before expiration as well. Also, options are typically 3 month contracts. There are long term options, but they are less common.
     
  7. senseless thread starter macrumors 68000

    senseless

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    #7
    If Hedge Funds aren't all that different from Mutual Funds, why don't the same rules apply?
     
  8. mactastic macrumors 68040

    mactastic

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    #8
    Hedge funds themslves are not bad. It's when they exist as a bank subsidiary designed to provide a convienent dumping ground for toxic assets that they become a problem.
     
  9. Desertrat macrumors newbie

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    #9
    mac's right. A good example is Goldmine Sucks selling toxic junk as AAA and then shorting that paper.

    For what's called "normal" behavior--or basic honesty in business--hedge funds provide a service in overall market stability.

    No business system of whatever sort at whatever level can function with any efficiency and stability without trust...
     
  10. mactastic macrumors 68040

    mactastic

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    Which also points out another problem, in that it should not have been possible to get AAA ratings from ratings agencies on such junk.

    Frankly I don't know how anyone trusts the ratings agencies again short of some major shake-up in how they operate.
     
  11. rhsgolfer33 macrumors 6502a

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    #11
    Because the people involved with hedge funds aren't your average investors. Mutual fund rules are largely designed to protect normal people from losing all of their money due to high risk behavior on the part of the fund manager that your average investor doesn't understand. Since most hedge funds require a minimum investment of $1 million, its fairly safe to say those investing in hedge funds aren't your "average" investor; they are far more sophisticated and risk tolerant (because they are simply wealthier) and don't really need the same protections that an average investor needs.
     
  12. mactastic macrumors 68040

    mactastic

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    #12
    They may not need protection from each other, but we certainly need protection from them.
     
  13. rhsgolfer33 macrumors 6502a

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    #13
    I agree with you that we shouldn't let depository institutions have hedge fund like investments or engage in overly risky investments. Other than limiting what kind of institutions can maintain a hedge fund like entity, I don't really see for many other limitations, such as limiting hedge funds to certain investments. I don't think creating some new regulations for banks is necessarily a bad thing, but that's pretty different from regulating a hedge fund.
     
  14. pilotError macrumors 68020

    pilotError

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    #14
    Separate banking and brokerage just like the old days. There was a reason it was that way to begin with...
     

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