Starting a Hedge Fund

15 Common Hedge Fund Mistakes (Part 5)

Written by Bobby Jan for Gaebler Ventures

Hedge funds are struggling these days, and much of this struggle might have been avoided. This article, the fifth in our series of six articles, discusses some of the mistakes that can cause a hedge fund to fail.

In previous articles in this series, we listed the 15 common mistakes made by hedge fund entrepreneurs and discussed mistakes 1 through 10.

Now, let's take a look at mistakes 11 and 12

• Mistake 11. Manager fails to development alliances and partnerships.
• Mistake 12. Portfolio manager loses objectivity and independent thinking.

Hedge Fund Mistake #11: Manager Fails To Development Alliances And Partnerships.

The investment industry is highly dependent on prestige, trust, and other perceptions. All else equal, a fund linked to a prestigious and trusted entity will gain advantage from the relationship and a fund linked to a tinted entity will be disadvantaged by the relationship.

Many entrepreneurs have the problem of being obsessed with independence. In the investment industry, this obsession may be a liability. Hedge fund managers should develop effective alliances and partnerships that may involve selling a portion of the found to another entity, not choosing a service provider based on cost alone, etc.

Hedge Fund Mistake #12: Portfolio Manager Loses Objectivity And Independent Thinking.

Investment professionals are paid for their expert skills. However, a common problem in the investment management industry is the herd mentality. The following are some of the reasons why portfolio managers lose their objectivity and independent thinking:

• The portfolio manager gives too much weight and trust to reputable research institutions.
• Following the recommendations of reputable analysts shifts the blame away from the manager.
• Losing money while following the crowd (other investment managers) generates less criticism then losing money while going against the crowd. (e.g. "Jack lost 10% of his money on IBM, who could've known!" vs. "Jack didn't buy Pets.com stocks and it went up by 30%. All the smart money was in it. Is Jack not with it anymore?")
• The portfolio manager might believe that others know something that he does not (i.e. responding to rumors).
• During times of intense market optimism or pessimism, the portfolio manager might lose objectivity and revert to emotional trading.

Hedge fund entrepreneurs must be aware of these problems and carefully monitor the actions of the fund's portfolio manager(s).

The Last of the Hedge Fund Mistakes

In the next article in this series, we will discuss mistakes 13, 14 and 15. That will conclude our discussion on common mistakes made when starting a hedge fund.

Cheng Ming (Bobby) Jan is an Economics major at the University of Chicago who has a strong interest in entrepreneurship and investing.

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