This may be the best time to invest in hedge funds.
For quite a few years in the past decade, it was easy for hedge funds to make money. If you increased your leverage and bought, say, structured mortgage products, you could make a killing. Hedge funds that used this strategy were showing awesome returns that easily beat most stock market indicators.
Most of these gains, however, were taken back when the housing bubble burst.
As it turned out, many hedge fund managers weren't trading wizards—they were just guys surfing the foam of a bubble. When the bubble popped, they crashed too.
Oddly enough, the same thing can be said of a few hedge funds that did well when the bubble burst. Bears who happened to be in the right place at the right time did amazingly well. But this wasn't necessarily because they were smarter than anyone else. When the market bounced back in 2009, some of these bears faltered big time.
What investors really want—what makes them willing to pay the big fees hedge fund managers charge—is a fund that doesn't just ride the cycle up or down. They want someone who rides it up AND down. That is, someone with an investment strategy that is flexible enough to make market beating profits regardless of the direction of the broader financial markets.
Fortunately, the amazingly volatile markets we've seen in the past few years have provided an opportunity for investors to find real market acumen. If a hedge fund did well in 2007, survived the crash of 2008 without real losses, made money during the government-subsidized boom of 2009, and then continued to do well when the government subsidies were withdrawn in 2010, that's a sign that the fund is run by agile, smart people with a real talent for moving with the market.
Questions? Comments? Email us atNetNet@cnbc.com
Follow John on Twitter @ twitter.com/Carney
Follow NetNet on Twitter @ twitter.com/CNBCnetnet
Facebook us @ www.facebook.com/NetNetCNBC