Best Practices? What Does That Mean?

Best practices? What does that mean? Yesterday there was a business story about new regulations regarding hedge funds. The article stated that there are about 8,000 hedge funds and about $2 trillion invested in hedge funds. Hedge funds are usually invested in by large pools of money like state pension funds. The idea behind investing in a hedge fund for say a large state employee pension fund is to manage the risk the total fund has through its exposure to the securities markets. This is usually referred to as risk management. In a regularly managed portfolio of bonds or stocks, the portfolio manager buys those securities it wants to hold and sells those securities it believes will not outperform the market. Why would a portfolio hold onto a stock if the manager believed that it was not going to out perform the market (that market’s index)? Portfolio managers that manage a portfolio of equities, hold those equities that they believe will outperform the market.

In a hedge fund, the portfolio manager or portfolio management team can decide to buy equities, or, they can decide to sell short those equities they believe will under perform the market. In other words, a hedge fund can make money for its client in both a bull or bear market. To sell short, the portfolio manager borrows the stock from someone that is long the stock and then sells it. When the stock goes down in price, the portfolio manager buys the stock back and returns it to the broker they borrowed it from. The difference between the price they sold the stock and bought it back is there profit less the expenses of doing the trade.

What I find so interesting about this article about new hedge fund regulations is the comment by the attorney general from the State of Connecticut. He called the “best practices” statement a “virtual farce.” That is pretty strong language for a state’s attorney general. Perhaps he has political aspirations too. Nevertheless, such a statement does cause one to stop and ask oneself, what does "best practices” really mean?

Senator Schumer, (D-NY) made a comment that in the interm, these “best practices” should strengthen the hedge fund industry and provide regulators and investors with better information. Spoken like a true politician from the state where Wall Street resides.

The “best practices” is suppose to increase the transparency and risk management for the investor and the hedge fund. The treasury secretary said it would. What I don’t know is whether the “best practices” is strictly voluntary or whether there are specific requirements concerning reporting?

Naturally the first defense against any new regulation that is rolled out is the fear defense. Improvements are welcome as long as they do not keep the US financial markets from being competitive in a global economy. If our house of cards falls down, who in the global economy is going to help us put it back up?

You know what this whole thing reminds me off? Letting the foxes draw up the specs for the construction of the chicken coop. Why not? At some point people have to wake up to the fact that unless we get serious about regulation, oversight and auditing, we are going to be visiting a financial crisis event ever few years. How can that track record make us more competitive in the global economy?

You know there is always a lot of talk about the fact that Americans do not save money. That American families live with too much debt. This is all probably true, but has anyone ever tried to see the relationship between not saving money and racking up debt? If our monetary policy paid as much attention to the integrity of the dollar, also known as protecting against its decline in purchasing power, then perhaps people would have an incentive to save money. But this is not the case. Monetary policy has for many years been run for the benefit of commerce, not the benefit of the consumer and the saver. With a currency that is losing purchasing power every year, the need to stay even or ahead of inflation causes the need to take greater risks when investing. Greater risks sometimes means greater profits, but not always. Today we find the financial services industry involved in a number of more risky investments while the money managers try to hold onto their bigger clients, who continue to put more pressure on the money manager for better investment performance.

Yesterday, the price of a barrel of oil reached a new high of over $114, and the US dollar continues to decline in value. It you think this whole things is starting to resemble the dog chasing its own tail, you probably have a pretty good handle on what is happening. Stay tuned.