Hedge funds are all about making lots and lots of money, not creating jobs
I just finished reading a Bloomberg Businessweek profile of hedge fund founder John Paulson.
And you know what?
In the entire six-page spread about a guy who runs one of the world’s largest hedge funds, there’s not one word about how many jobs he’s created.
You know why?
Because creating jobs isn’t what hedge funds do.
Hedge funds exist for one reason and one reason only -- to make their owners and investors incredibly rich.
I know Mitt Romney has tried to sell the idea that these lightly regulated, risk-embracing mutual funds on steroids are somehow concerned about creating jobs.
But I have a hard time taking such a claim seriously, based on the very nature of the beast.
Let’s review the facts.
Hedge funds aren’t open to everyone.
Individual investors are typically required to earn at least $200,000 a year and have a net worth in excess of $1 million.
They’re expected to put at least $100,000 into the fund and often more. Sometimes a lot more. It’s not uncommon for hedge funds to require a minimum commitment of $1 million.
Once you’re in, it’s hard to get out.
Hedge fund shares can only be redeemed at certain points during the year, and managers can declare “lock up” periods where investors aren’t allowed to take out any of their money.
The management fees are steep. Much higher than for the regulated mutual funds we buy for our 401(k) plans.
Hedge funds typically charge an annual fee of 1% to 2% of the fund's assets plus a “performance fee” that claims 20% of all profits.
What do hedge fund investors expect for all of this?
They expect to make far more money than they possibly could earn investing in stocks and bonds like you or I might do.
That’s why Paulson was a rock star in the hedge fund world when his Paulson Advantage Plus fund posted a 158.6% gain in 2007, but the Businessweek cover story labeled him “The Big Loser” after it lost 52.5% in 2011.
So it’s important not to kid ourselves about what hedge funds are and how they work.
Hedge fund managers go to extreme lengths to make lots and lots of money, such as using complex derivative contracts to bet that a tidal wave of homeowners were about to default on their mortgages.
That’s how Paulson made his billions in 2007.
Or they might become the biggest shareholder in a Chinese timber company on speculation it might be a takeover target.
That’s one of the moves that caused Paulson to crash in 2011.
Sino-Forest’s stock price plummeted after another Wall Street firm’s research report questioned the veracity of its financial statements and whether it truly owned all of the forest land it claimed.
Even if your strategy includes buying and revamping American companies, as it was at Romney’s Bain Capital, the goal of turning a quick, substantial profit remains the same.
Any jobs created by the hedge fund industry’s balls-to-the-wall scramble for eye-popping returns are pure serendipity.
Just imagine that I’d been an investor in Bain Capital.
Mitt walks up one day and says he’s working on a deal to restructure a company that won’t generate a lot of cash but would create 1,000 new jobs.
I’d have told him to get back to work and make me some money.
As he walked away, I’d have been shaking my head and muttering under my breath, “What kind of crazy hedge fund is this?”