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Hedge Funds: Going, Going... Gone?


In a declining market, look for high rates of attrition.

Before the market downdraft, there were about 10,000 hedge funds with an estimated value of $1 trillion.

Look for about half of them to disappear - but don't worry. It's healthy.

"There will be a lot of carnage," says Todd Harrison, founder of Minyanville and former president at the $400 million Cramer Berkowitz fund. "This is a cleansing process. There's a lot of leverage that's being unwound. A lot of funds are liquidating winners to finance sinners."

Investors pulled about $43 billion out of hedge funds in September. Money under management will continue to decline and funds will continue to take hits in a declining market.

Hedge funds appear to be an acceptable casualty in the eyes of government, as well as those of many small investors. But Main Street won't escape the fallout as the sector contracts.

Hedge funds are a mystery to many individual investors, and are often regarded as being volatile and leveraged to the hilt. The reality is more complex. A hedge fund can take both long and short positions, use arbitrage, buy and sell undervalued securities, trade options or bonds, and take a position in just about any opportunity in any market.

While strategies vary greatly, many funds hedge against market downturns. The goal: Use a range of techniques to reduce risk, boost returns and limit the correlation with equity and bond markets. In short, the means may be buccaneering but the goal is conservative.

Many fretted that risk-happy hedge funds someday would crash the world's financial markets. Instead, it was thumb-sucking mortgage lenders and established investment banks that gave the world a glimpse of Armageddon.

But that doesn't mean hedge funds are in the clear. In fact, hedge funds may be the next sector to fall.

So far, major funds have taken a hit, but haven't been shattered. One reason: The funds were conservatively managed, contrary to their gunslinging image in the general press. Paradoxically, it looks like most hedge funds took fewer risks than some investment banks.
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