Hedge for the masses, come on…

Saturday’s front page feature story in the Money and Investing Section of The Wall Street Journal was all about hedge fund replication. Through exchange-traded funds and other products, firms like Deutsche Bank, JP Morgan, Rydex, Index IQ, and Goldman Sachs are creating investment vehicles that clone hedge fund portfolios and offer small investors similar -- if not better -- returns than the real thing, if you believe the hype.

Don’t you believe it.

The reality is that it’s just another example of Wall Street taking advantage of Main Street.

There is nothing that can be cloned about a hedge fund, its managers, or its returns. These big-name copycats are just wrapping their pigs in a hedge fund poke to take advantage of the public’s appetite for anything called an “alternative investment.” In my opinion, the issuers stand to make a lot of money while leaving the investors scrambling for scraps. I believe the regulators should spend a lot more time investigating how these products work, especially verifying claims about how well they’ll perform in all sorts of market conditions.

A real hedge fund is designed to increase assets in up markets and to protect assets in down markets. This is what hedge fund managers aim to do for investors, and the managers use all their skills, tools and investment prowess to hit their targets. It’s silly to think that you can replicate the mind or investment skills of Julian Robertson, George Soros, George Hall, Paul Tudor Jones, or Lee Ainslie. That’s why I would recommend that if you’re interested in buying one of these clones, instead stuff your money in their mattress or hide it in a coffee can in the freezer. Your returns might be better.

And now the answers to your questions:

Last week I got a number of queries from people asking why they should use a lawyer who specializes in hedge funds and who has offices in a major financial center.

The answer is that if you’re trying to build a hedge fund that is going to go after both high-net-worth investors and institutional assets, you need to use service providers that are well known to and well respected by investors. First, you can be sure that your fund will be created properly and meet all market specifications; second, you won’t have to explain to potential investors why you choose the lawyer you did; third, you’ll have the help of a professional who knows how to build a business.

It’s hard to raise assets. Potential investors aren’t eager to give money to new managers and will use any pebble in the path to explain why they can’t justify investing with you. By using an unknown lawyer, you’ve put a boulder in the road before you even get started. You’re better off using a firm that has a well-respected, well-rounded hedge fund practice right from the start. In the end, using a lawyer with a good track record in the hedge fund industry will serve you for years to come.

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