If you are invested in a hedge fund, you should read Martin Wolf’s explanation of why today’s hedge fund industry may not survive. Mr. Wolf argues that the hedge fund industry is bound to attract “the unscrupulous and unskilled,” because it’s hard to distinguish luck from skill. He further argues that most hedge funds follow strategies that have “a high probability of a modest gain and a low probability of huge losses in any period.”. The implication here is that the hedge fund industry has been picking up pennies in front of the steam roller, and that a doomsday event could wipe out the industry.

Photo:B-Tal, Creative Commons, Flickr

My take? Given the wide array of hedge fund strategies, I’d be hesitant to make such sweeping statements. There are many ways to isolate sources of performance (e.g. regression analysis, factor models etc.), so it might be a stretch to suggest that hedge funds always reward lucky managers as opposed to skillful managers. It’s silly to put all your eggs in one basket, and hedge funds should be discussed from a portfolio perspective. In isolation they can be a risky investments, but they offer great diversification benefits when combined with a stock and bond portfolio.

If you feel like another dose of doom and gloom, read this too.