Hedge Funds the Trillion Dollar Bet
"The market can remain irrational longer than you can remain solvent"
John Maynard Keynes
In 1993, Myron Scholes and Robert Merton joined forces with John Meriweather, the legendary bond trader of Salomon Brothers. With 13 other partners, they launched a new hedge fund, Long Term Capital Management, which promised to use mathematical models to make investors tremendous amounts of money. Their money machines reaped fantastic profits, until their theories collided with reality, and sent the company spiraling out of control. The crisis threatened to bring markets around the world to the brink of collapse.
The lessons from the collapse of LTCM are that the fee structures charged by hedge funds – and indeed actively managed conventional funds – are unjustified in most cases. Hedge funds are not an alternative asset class, they are simply a compensation structure.
Equally, leverage or borrowing to invest is a double-edged sword since magnifiying gains on the way up means that you are also magnifying loses on the way down.
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