Last week, I took the Wall Street Journal to task for publishing a "Heard on the Street" column that did little more than spread hedge fund industry hype. In that blog posting, I asked Journal staff to look into four questions related to the relevance and validity of the facts asserted in that column. On Saturday, the Wall Street Journal addressed the first of those four questions, publishing an article about how statistics related to the size and growth of the hedge fund industry are manipulated. Reporters Alistair MacDonald and Margot Patrick placed some phone calls and turned over a few rocks. Here is what crawled out: 1. While it is established practice for investment funds to report their size in terms of investor capital, many hedge funds substitute total assets for investor capital when reporting their size. Because hedge funds routinely leveraging themselves up to ten times, this can allow a $100 million fund to misrepresent itself as a $1 billion fund. Call this approach to reporting what you want. I call it lying. 2. With many investors looking to a fund's size as an indication of success, this misleading reporting might induce investors into a small fund by making them think they are investing in a large, successful fund. 3. The misleading reporting inflates estimates of the industry's size and growth. Those estimates are blatantly unreliable. The Journal cites two disseminators of hedge fund propaganda: Hedge Fund Intelligence and Credit Suisse Tremont. One claims the hedge fund industry controls $2.48 trillion in capital. The other cites a number half as large. That is a big discrepancy. 4. There are other factors that can distort or bias such statistics. One is double-counting of assets invested by funds of funds. The Journal mentions RAB Capital, plc., who have a fund of funds that invests about $500 million in the groups other hedge funds. The Journal doesn't even touch on the gaping conflict of interest here, but they do confirm that RAB double reports the assets to data distributors. Double counting doesn't require that a fund of funds and the hedge funds it invests in be managed by the same group. Conceivably, all fund of funds assets may be double counted. I applaud the Journal for shining a light on a small fraction of what is unseemly about the hedge fund industry. But there is more work to be done. In my last blog posting, I asked three other questions that need to be addressed. There are a lot more rocks to turn over. We now know many hedge funds are being creative when reporting their capital. On its own, this revelation is a drop in the bucket, but it contributes to a river of disturbing evidence. I suspect the hedge fund industry is a sham with consequences as far-reaching as the dot-com bubble seven years ago. Glyn A. Holton
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