UK – Consultant PricewaterhouseCoopers (PWC) has published a stinging criticism of the current trend for pension fund investment in hedge funds, an investment ‘boom’ that it says bears some of the hallmarks of a classic bubble.

In a report, entitled “Hedge funds – today’s fad?”, PWC rebukes the herd effect of pension funds towards this years investment fashion, adding that the party may already be over with so many investors starting to pile into the asset class.
“Last year, investors piled into private equity; this year they are bingeing on hedge funds. “Inevitably, returns are chased downwards. Followers of herds never make money.”

Noting that it is only three years since the Long-Term Capital Management debacle, the report notes wryly: “The time between bubbles seems to be how long it takes to forget the past, plus one day.”

PWC points out that one of the traits of a hedge fund – investment shorting; when an investor does not own the stock, but borrows it, intending to buy it back when the price has fallen, is very risky in that it can mean unlimited liability for the investor should the market call be wrong.
The report also notes that hedge funds tend to operate on a performance-related fee basis, which is often expensive – sometimes between 1%-2% of assets plus 5%-25% of profits.
It adds that for better or worse, the hedge fund manager is incentivised to take risk.

Conceding that a case can be made for pension fund investment in hedge funds that are weakly correlated to long bonds and equities, the report concludes by saying that it is still not at all clear if these low correlations are maintained when they are most needed – in market declines.