Beware the Financial Adviser Selling Hedge Funds

By Kim Allen

If you listen to the hype, hedge funds are the best thing since sliced bread and are suitable for all types of investors.

Promoters of these funds claim you can earn higher returns than traditional funds, but with lower risk.  They hope you won't remember the collapse 9 years ago of Long Term Capital Management.  LTCM was bailed-out to the tune of $3.625 billion by the major creditors to avoid a wider collapse in the financial markets.

Well, it's happened again, and this latest collapse should serve as a warning to anyone invested in these types of funds.

Last week, New York-based Bear Stearns pleaded for help to rescue two of its hedge funds teetering on the brink of collapse.

Merrill Lynch & Co., which pumped $300 million into LTCM, said no and seized $850 million of bonds held as collateral for loans it had made to the funds. Other lenders also pulled out, leaving Bear Stearns in a pickle.

Without assistance from his Wall Street peers, Chief Executive Officer James E. Cayne, was forced to salvage the healthier of the two funds, offering to put $3.2 billion of capital at risk in the biggest bailout since LTCM. Bear Stearns may dissolve the second fund after more than $600 million of investors' money dwindled to less than $200 million.

The decline turned into a tailspin last month when Bear Stearns suspended redemptions in the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leveraged Fund. Barring investors from withdrawing money from a hedge fund typically is the first sign of an impending collapse.

Bear Stearns's enhanced fund, which at its peak borrowed 10 times its equity, and the Bear Stearns High-Grade Structured Credit Strategies Fund, a similar pool that wasn't as highly leveraged, speculated mostly in high risk bonds and high yield..

They looked at these high yields, this growing market, and forgot the basic concept of risk and return.

Note, we still see a place of hedge funds in some portfolios however it is important before investing in these funds that you fully understand the risk.

Please contact AAM Townsville on 07  4771 4577 for all your investing needs.