As yields on stocks and bonds continue to hover near zero, pension funds and retail investors are diving head first into the murky, rocky end of the investment pool: Hedge funds. According to a recent Citigroup report, hedge fund investments are expected to more than quadruple from today's record high of $1.2 trillion to more than $5 trillion.
And Wall Street, of course, couldn't be more delighted. The fees for hedge fund managers are some of the biggest on the Street- management fees typically are 2% and performance fees are usually 20%.
Wall Street bankers routinely tout hedge funds as a way for institutions such as pension funds and endowments to diversify and manage risk. They also point to high-profile investors such as the endowment for Yale University, which enjoyed "a higher-than-average rate of return on its endowment through its alternative investment strategies, including hedge funds," according to a recent article by Kristin Jones in the Wall Street Journal.
What Wall Street bankers pushing hedge funds won't tell institutional or retail clients about is the tens of billions of dollars locked up in hedge funds known as zombies. Clients with money in such funds face the horrific dilemma of paying management fees to hedge fund managers, even though they can't get their hands on their money.
A posting earlier this month sums up this zombie hedge fund problem. According to this DealBook article by Jay Eisenhofer and Matthew Morris:
Four years after the onset of the financial crisis, tens of billions of dollars remain locked up in illiquid 'zombie' hedge funds that suspended their redemptions in the darkest days of the meltdown,
Today, these funds produce little if any financial return for their fiduciaries while their administrators continue to coast along, sitting on fund assets without making any effort to liquidate and return their holdings-yet still collecting their management fees.
Citing an industry publication, DealBook reported that, at the worst of the market turmoil in late 2008, an estimated $175 billion of capital was locked up in illiquid hedge funds. It is estimated that some $50 billion to $60 billion remains locked up in zombie funds, out of the reach of investors.
A few investors seeking the return of cash have recently won lawsuits against such zombie funds, but such legal wins are still extremely rare.
Given the extreme risk of hedge fund blowups like Goldman Sachs's Alpha Fund and frauds such as Bernie Madoff, investors should look to see if there is water in the pool before they dive. After all, one careless leap could wind up turning their capital into a zombie.
Disclosure: Zamansky & Associates are securities attorneys representing investors in federal and state litigation and arbitration against financial institutions, including Citigroup and Goldman Sachs.