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Alternative Assets: The Main Innovation is in Compensation Structure

In a video segment entitled Hedge Funders Protecting Capital, CNBC provides a great deal of ignorable commentary. For example, the commentators refer to the hedge fund "asset class," almost willfully ignoring the obvious: hedge funds are not an asset class but represent an innovation in compensation structure.

Unlike long-only mutual funds, hedge funds were originally sold as a way to "hedge" downside risk. Additionally, the 20% carried interest was meant to align interests between the hedge fund manager and his investors.

Unfortunately, many hedge funds have become a wealth creation vehicle for portfolio managers at the expense of their investors. One of the main methods of achieving this wealth creation: leverage.

The CNBC video (at 1:05) shows a slide with the words - "Will They Ever Learn to Lever Again?" It is reported that at historical market tops, the leverage ratio for the hedge fund universe is 1.7x-1.9x.