Sep. 23–You don’t have to be a Rockefeller to hedge against market calamities, but it helps.
Most of the hedge funds that often beat the market with well-placed bets on trends in interest rates, currency-exchange values, and stock prices are offered only to institutions and well-heeled individuals — those with net worth of more than $1 million or annual incomes of $200,000 up.
But with most of us stuck with three straight years of double-digit stock-market declines, the hedge funds looked mighty good by comparison, at least for a while.
Some greatly outperformed the market as a whole. And even last year, which was a stinker for the markets, the average hedge fund turned in a performance that ranged from flat to slight gains.
It’s small wonder, then, that hedge funds doubled in number from 1998 to early this year, rising to about 4,000 with assets valued at an estimated $600 billion.
There’s no reason for us average Joes to feel left out of this bonanza.
We can do just like the best of the hedge funds: All we have to do is act decisively, with a great deal of nerve, make our bets on trends, and then sit back and wait for the reward that will inevitably be ours.
OK, here’s all we have to do: Figure out whether interest rates will stay low for six months, a year, or two years; forecast whether the stock market will rise 6 percent, 10 percent, or 15 percent next year (or whether it might drop instead); and predict whether the housing boom will continue to reward mortgage holders and whether housing prices will rise or go bust.
Take interest rates for example. With the prime rate at 4 percent, many homeowners can obtain home-equity loans at, say, 4.5 percent.
At that rate, a $25,000 home-equity loan would cost just $1,125 a year, or about $94 a month, for the interest portion.
Why not keep the loan, instead of paying it off right away, and divert a few hundred bucks a month to pay down higher-interest obligations such as credit cards?
Sounds good so far.
But what happens if interest rates start to gallop again? At 8 percent, that same loan costs $2,000 a year, or $166 a month, just for interest, and at 10 percent (the going rate just a few years ago), it would run $2,500 a year, or more than $208 a month (and not a dime of that going to principal).
What about the stock market? Those who converted everything to cash or government securities as the market crested in early 2000 can congratulate themselves: They avoided a stomach-wrenching drop of 30, 40, or even 50 percent in their portfolio.
However, if they wait too long to get back in the market fully, they also risk missing out on the next bull market (assuming for the moment there will be one).
And on it goes.
Those who waited this long to buy a home might be tempted to wait a bit longer. If all that talk about a housing “bubble” is true, maybe a house would be a bit cheaper next year.
But housing prices may just keep rising.
If you want to operate your own miniature hedge fund, go right ahead. Make those brave choices.
If your bets are winners, you can pat yourself on the back and reap your reward.
If you’re wrong, you can at least console yourself with the knowledge that even the biggest hedge funds sometimes guess wrong.
In 1998, for example, a Russian bond default cost the Tiger Fund and George Soros’ Quantum Fund billions of dollars, and only a $4 billion bank bailout orchestrated by the Federal Reserve prevented Long-Term Capital Management from going under.
Last year, Lipper & Co. was forced to liquidate three hedge funds after losses of well over $300 million.
Hundreds — as many as 800 — of hedge funds closed last year, either because of losses or performance lower than investors had expected.
And now hedge funds are coming under increasing regulatory scrutiny and could face new regulations from the U.S. Securities and Exchange Commission, especially after the recent revelation that several mutual funds allowed a hedge fund — Canary Capital Partners LLC — to place trades after normal closing hours.
Go ahead if you dare. But most of us don’t have the nerve to act totally like a hedge fund — and that could be a very good thing.
A few well-placed bets should be enough for just about anybody.
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