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On money

Heydays of hedge funds can't last

By HELEN HUNTLEY
Published April 16, 2006

Hedge funds may have $1.5-trillion - maybe even some of your pension money - but the mania can't last, predicts James Riepe, hedge fund critic and competitor. When it ends, it's more likely to be with a whimper than a bang, he said.

Riepe is retiring as vice chairman of money manager T. Rowe Price and is former chairman of the Investment Company Institute, the trade group for the $9-trillion mutual fund industry. This month he was in Tampa talking to members of the Florida Venture Forum, the Association for Corporate Growth and the Wharton Club.

His message: Don't get taken in by the hedge fund hype. Investors expecting outsized returns are likely to be disappointed.

"There's too much money pursuing too few strategies," Riepe said. "To me it's a very scary area."

Mutual funds and hedge funds charge fees to manage money for others; hedge funds just get bigger ones (like 20 percent of the profits). But mutual funds operate under far more regulations, including diversification and reporting twice a year to the SEC. Hedge fund advisers just have to register.

The concept is that hedge funds offer wealthy investors the chance to make big bets and earn outsized returns whether the stock market is going up or down. Some sell short (a bet that stocks will fall), some bet on mergers, some on interest rates, currencies or commodities. Some take big stakes in companies, such as Tampa's Walter Industries, then pressure managers to make changes that could produce a big payoff.

Riepe predicts that the hedge funds' marketing pitch - big profits - will be their undoing. When the huge profits aren't there, investors will bail out as soon as they can. (Withdrawals are restricted.)

Part of the expectation problem is that industry statistics for hedge funds are inflated by selective reporting and survivorship bias. While poor performing mutual funds go out of business, in the hedge fund industry, some studies have found attrition rates as high as 15 to 20 percent a year.

Hedge fund investing is restricted to institutions like pension funds and wealthy investors. Being part of an exclusive club is part of the allure if you're a millionaire. However, some mutual funds offer small investors the option to get in on hedge fund strategies under the protective umbrella of SEC regulation.

Of course, it's still possible to lose money no matter what investment you choose.

Your recent article concerning a high checking account balance really hit home with me. However, I know that investing for extra income will be expensive at tax time. While I was working, I signed up for a payroll deduction that bought savings bonds. After I retired, I cashed in several bonds and the $25 bonds were now worth $74. However, the interest income came back to haunt me at tax time. Do you know of any high-yield offerings that generate income that will not increase my tax burden?

Your attitude is all wrong. What matters is not whether you owe taxes, but how much you have left after the taxes are paid. It sounds as though you would have preferred for your savings bonds not to increase in value.

If you want a short-term tax-free investment, look for a tax-free money market mutual fund. You can find the top-yielding taxable and tax-free funds in the Sunday business section under "money market yields."

But don't assume tax-free is better than taxable until you run the numbers. Last week the top-yielding taxable fund paid 4.74 percent while the top-yielding tax-free fund paid 3.19 percent. If you are in the 25 percent tax bracket, you would get to keep 75 percent of that 4.74 percent taxable yield, or 3.56 percent. That means the best taxable fund beats the best tax-free fund. On the other hand, if you are in the 35 percent tax bracket, the tax-free fund is the winner.

Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to hhuntley@sptimes.com to Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731, or log onto www.sptimes.com/blogs/money where you also can see other questions and answers.