The Pervasion of Pseudo-Hedge Funds

March 14, 2016
by Noriyuki Morimoto

By definition, hedge funds are instruments that hedge market risk. In reality, however, there are very few authentic hedge funds that manage to hedge market price fluctuations, while most of the others are inevitably influenced by the market. Therefore, it becomes necessary to diversify across a large number of hedge funds as well.

This situation does not make logical sense. If the definition of hedge fund is loosened to cover a wide range of funds, resulting in the need for diversification, it makes more sense to say that the true purpose of hedge fund investment can be achieved only by selecting a small number of strictly defined hedge funds.

Hedge funds originally comprised a small category targeting high-net worth investors. Thanks to their small scope, they were able to deliver the strict strategy of hedging market price fluctuations and profiting from market inefficiency. On the other hand, however great the demand may grow, there is a limit to supply. If demand grows beyond that limit, the definition of hedge fund will be loosened, resulting in the pervasion of pseudo-hedge funds.

Then, how should we invest in authentic hedge funds? Due to the limited supply of such funds, most of them are unlikely to accept money from investors other than existing clients. That makes it impossible to invest in them in the first place.

So the only way will be to invest in new funds created by competent managers. We can refer to past performances to determine excellent existing funds, but for new funds we have no choice but to trust the philosophy and CV of the manager. To make good choices, we have to gain skills similar to those of a connoisseur of antique items.

If you wish to invest a large amount of money in hedge funds, you will surely have to diversify across a large number of pseudo-hedge funds. If you wish to invest in authentic hedge funds, your only option is to put a small sum in competent hedge funds that are newly created. This is the reality of hedge fund investment.

Noriyuki Morimoto
Noriyuki Morimoto

Chief Executive Officer, HC Asset Management Co.,Ltd. Noriyuki Morimoto founded HC Asset Management in November 2002. As a pioneer investment consultant in Japan, he established the investment consulting business of Watson Wyatt K.K. (now Willis Towers Watson) in 1990.