Book Review: The Hedge Fund Mirage

If you want the truth about hedge funds and how to invest in them, The Hedge Fund Mirage: The Illusion of Big Money and Why It's Too Good to Be True is a must read. An especially important picture of a major part of financial services, this book provides insight into a field of which little information is publicly available.

Despite the increased fortune hedge funds produce, their investors barely profit. As the book reads, “investors would have made more putting their money into treasury bills instead.” Currently risks and returns favor the hedge fund managers. Of course, this was not always the case. During the 1990s, there were fewer hedge fund investors, which, to some degree, allowed for greater profitability. Owing to this shocking truth, author and hedge fund expert Simon Lack provides an in-depth inside look into the world of hedge funds in an effort to help put the investors back on top.

Lack was part of JPMorgan Chase's hedge fund incubator fund. In this capacity, he participated in interviews of potential start-up hedge funds. Once these funds were financed, the fund got information on the hedge fund trades, portfolios, strategy, and business. If the start-up hedge fund was successful, the incubator fund got a percentage of the operator's income. Only a very small number of all the start-up candidates received financing from JPMorgan Chase.

The ongoing information on the hedge fund trades showed how the successful hedge funds made money. The prime broker operations of the major banks get this useful input. However, this very valuable information is not distributed to the investors. This gave Lack some unique perspective on the hedge fund business. His book shares some illustrative stories on the hedge funds he helped finance. Readers get a priceless education on one of the largest and most profitable parts of the financial services industry—for the price of this book.

Investors in hedge funds will get some unsettling conclusions from this book. The main lesson is the "transfer of wealth to the hedge fund industry from its clients." After his analysis of hedge fund returns, Lack concludes, "While the hedge fund industry has created some fabulous wealth, most investors have shared in this to a surprisingly modest extent." Although the hedge fund folks will likely question this conclusion, it’s clearly buyer beware. But they need not be too concerned. Today's low interest rates will push a lot of dollars into hedge funds in hopes of much larger returns than from government bonds.

Although recent times show otherwise for investors, it should be noted that this can be a very profitable business. The top 25 hedge fund managers collectively earned $25.3 billion in 2009. Another attraction is hedge fund compensation does not receive the type of angry government and media attention that is directed at the bonuses of investment bankers.

Note: Simon Lack will present his book at NYSSA's Author Series: Simon Lack: The Hedge Fund Mirage February 9 at 6:00 p.m.

–Bill Hayes