Yet Another Hedge Fund Cautionary Tale
Simon Lack, the author of The Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to Be True famously issued a challenge for anyone to show that they became rich through investing in hedge funds. After nine years, it is still unmet. With their perverse fee structures, there is no shortage of hedge fund managers who became rich even if their investors did not.
If the challenge had been the opposite, to find someone who became poor, we have the recent example of the hapless investors in Tampa-based OptionSellers.com. The founder and manager of this fund (James Cordier) announced on YouTube that a “rogue wave” had “capsized our boat.” In less poetic language, the $150 million fund with 290 investors was completely wiped out.
You may ask, “How does this happen?” The answer is naked shorting of call options, an extremely risky trade with potentially unlimited downside. To make matters even worse, the investors are on the hook for the margin money that Option-Sellers’ clearing firm put up to close those positions. This means that they lost more than 100% of their actual investment. Let that sink in. Gregg Opelka of the Wall Street Journal ironically notes that even investors in the Madoff Ponzi scheme have recovered about 75% of their outlays because rather than taking insane risks, Bernie Madoff socked away the proceeds into bank accounts to support his lavish lifestyle, but even he wasn’t able to spend all that money.
Of course, it would be difficult for the investors to claim ignorance of the basic strategy, as it is pretty much spelled out in the name of the fund, but they might have thought that there would be some type of reasonable hedging since, after all, it is (or rather, was) a hedge fund.
As always, we advise investors to stay well away from hedge funds, as it is a game that they are unlikely to win, and losing can be extraordinarily painful.
At Clarity Capital Advisors, we are flat fee, fee-only, fiduciary wealth advisors.