The Big Secret Wealthy Investors Don't Want You to Know

Wealthy investors are different from you and me. They have a secret they don't want anyone to know.

They are bigger suckers.

How can this this be?

They qualify as "accredited investors" who can invest in deals exempted from SEC registration. Without SEC registration, the sponsors of these deals can avoid troublesome filing requirements that require detailed disclosures about transparency, limitations on fees and liquidity.

This means they can be enticed to buy "alternative investments" like hedge funds and private equity deals.

How is that working for them?

Not well.

According to a web site that tracks hedge fund performance, since late 2006, 117 hedge funds at 71 fund families have "imploded." The fund mangers don't include just miscreants like Bernie Madoff. Carlyle Capital, Bear Stearns, Dillon Read (run by UBS) and JPM Partners all made the list.

The news was not bad for everyone. The sponsors of these funds did just fine. For example, the UBS-run Dillon Read Capital Management hedge fund closed after losing $124 million in the first quarter of 2007. When UBS closed its hedge fund group, it incurred costs of $300 million.

Where did that money go?

According to the New York Times, "...$200 million went to severance payments and other costs for the hedge fund manager and his team."

Now I understand.

The investors get clobbered. The fund manager and his "team" get rewarded.

Here's the ultimate irony.

When wealthy investors seek legal redress against the firms that put them into these deals, they are confronted with the defense that they are "sophisticated investors" who should have known better. It usually works.

The rest of us can learn a valuable lesson from the foibles of the rich.

They are no match for the securities industry.

We aren't either.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.

 

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Comments

[tuberider]

I feel so much better now. Thanks, Merle, Tent City, USA

[josephXY]

The wealthy investors were obviously watching and influenced by the same financial experts / pundits
like everybody else. The video with Peter Schiff and the other financial experts forecasting in 06 / 07
is, if unknown, a must - see, it explains a whole lot in ten minutes:
http://www.youtube.com/watch?v=2I0QN-FYkpw

[seawolf77]

You are correct anyone can get suckered, but the truth is getting suckered usually means a republican businessman who screws you over either at the car shop, boat shop, cleaners, grocery store, resturaunts , mortgage broker , realtor etc etc etc. When you join the club you stop getting screwed over and start looking to screw, like any newly minted newbie vampire should. Then there are those who pretend to be vampires so that no one suspects them for not being blood suckers so they can safely co-exist in their place of residence.

[DuganS1]

What about the hundreds of hedge funds that have far out-performed the market and the mutual funds that have been slaughtered? How has Heebner's beloved CGM Focus Fund been doing over the past 12-15 months? How did the bear funds perform during the financial crisis? How about the large number of long-short hedge funds that were up last year? etc. etc.

[AmericanFool]

None of those questions mean much unless you have some data that can put them in perspective. The thing about Index funds is they grab a reasonable average. Hedge funds (outside of a fund of funds) do no such thing... when you invest, your entire investment is in a single fund... which takes you back to Dan's point, which one? Again, look at Amaranth, it just grew like wildfire until the implosion which took down the entire company.

[Mnemanth]

Big secret...
Shhhh!
"You give me your money, I make money off of it, and I give you a tiny percentage to keep your interest!"
Yeah, big secret.

[ThirdPartyTime]

Dan,

Here is my question. What about ETF's as opposed to Index Mutual Funds? Is there a significant difference other than the commission paid to purchase shares of the ETF? Isn't even the most conservative Index Mutual Fund going to charge high enough fees to east up the commission cost of the ETF?

[Dan Solin - Huffpost Blogger]

These ETFs are worthy of consideration:

iShares MSCI ACWI Index (ACWI);
iShares Barclays Aggregate Bond (AGG).

Generally, my problem with ETFs is that they encourage trading or picking asset classes that investors believe will outperform.

[DuganS1]

The AGG Aggregate Bond fund wouldn't be a good investment at current prices. Investors would be better served buying any various consumer staples stocks which are priced at 20 year low P/E ratios and have the same or better yields than the AGG. Utilities are still fairly cheap here as well and have good yields relative to bonds. The consumer staples will also benefit from a weak dollar and inflation (when it comes), whereas the bonds will get killed when inflation comes.

[FreedomCorpse]

There are articles out there on 'the web' that claim hedge funds are the last bastions of non-interventionist distorted capitalism left now. I think they believe that because the hedge funds are betting a lot with futures and options trading and are raking in the dough aka John Paulson's thing last year. I think hedge funds are ruining markets with these 'strategies'.

However, in my 401k plan the options for investing do not have places to invest that I believe are sound and almost all of them have an average of 15% used in derivatives trading which I am totally against. So, the past few years I've put much less in my 401k and the funds within the plan I've put in are ultra conservative and have privately invested in sectors that I believe are downwardly manipulated and severely undervalued. The result has been no losses in my 401k while everyone has lost up to 40% or more which have recovered somewhat in this bear market rally (in my opinion and others) and my private after tax investments are all up and it is looking better all the time (all with bull signals in this bear market)..

It is my opinion that it precisely the lack of granularity in 401k plan funds that makes investment in those plans precarious at best and subject to the whims of an investment market that is totally distorted and leaves the vast majority of investors in 401k plans as cannon fodder.

[RRoadrunner]

Wise advice...recouped 72k since April.....

[DASChicago]

Nice piece Mr. Solin;

They didn't want anyone to know that their their wealth, accreditation or special exemptions (from ethics) does not shield them...far enough. Guess they now know that plutonomy is Risky?

[Rule Of Law]

Hale, you always seem to come down squarely on the side of ordinary working folks in your column's, so let me ask what I've asked many other economics and investment writers here on HP.

My belief is that this is far from over, that many shoes are left to drop, inflation waits in the wings, and currency devaluation (or even recall) a distinct possibility. What program can working and middle class people put together Right Now, that will help to protect their income, assets, and investments for retirement--401-k, IRA etc--so that they can weather the coming storm.

Even though you've pointed out how easily fleeced the uber-wealthy Can be, the fact remains that they almost always come out of these crises in better shape than when they went in, especially relative to the rest of us. I know alot of that is insider info and connections in govt. that most of us will never have. But what about real world strategies that will allow us to do more than just survive, perhaps even have a positive effect on the policies that run the country through our collective actions.

No one wants to touch this. Any help?

[Dan Solin - Huffpost Blogger]

Here's my advice:

Save 15% of your annual income while you are working (including the employer match of your 401(k) plan) and spend only 4%- 5% per year of your savings in your retirement.

Buy a risk appropriate, globally diversified, small and value tilted portfolio of index funds anytime you have money to invest. Hold. Rebalance. Loss Harvest.

Only sell your investments when you need the money.

Do not do business with any broker or advisor who tells you they can "beat the markets."

Do not buy individual stocks or actively managed mutual funds.

[drkazmd65]

Excellent advice,... and I am already following (or attempting to follow) most of it.

90% of what I am saving goes into relatively well balanced & diverse stock & bond funds - most via my 401k and employer match.

The other 10% is going into buying some select decent growth stocks. Of those individual stocks, I haven't sold anything since Spring & don't intend to start now. Several of those stocks I got at the 'bottom' in March & April and I have set for Dividend Reinvestment. Unless something really tanks or rockets off - I will only sell to rebalance.

[petef59]

Green, Progressive & Farm-Labor party candidates in every county election for the next ten years.

[AmericanFool]

Dan, I'm sympathetic to your point, but this one could have used more prep work. I'm not going to claim certainty, but I've read from some sources that hedge funds in general did ok during the crisis. Sure there were implosions, but there were some big successes too, and there are a lot of hedge funds out there. I still agree with your key points however... the risk is bigger than investors realize, and their chances of going belly up a lot greater than most hedge fund investors realize... all hedge fund investors ought to have to read about Amaranth before investing! Another target is the Endowment Model, Faber's Yale version and others that have been publicized... their results may do a better job of making your point than the one you chose. Regardless, you are providing a valuable service, keep up the good work!

[Dan Solin - Huffpost Blogger]

You are correct. Some hedge funds did okay. Some did not. Here'are some issues to consider:

1. How do investors know which ones will outperform in the future?
2. How do investors measure the risk of the fund they select?
3. What value should investors put on the lack of financial transparency and illiquidity?
4. Should investors believe that hedge fund managers have found the holy grail of investing: more reward with no additional risk? If so, where is the data supporting that assumption?
: