Hedge Fund IPO: Euphoria or Irrational Exuberance?

History was made today at the New York Stock Exchange, when Fortress Investment Group made its Wall Street Debut, becoming the first major hedge fund to stage an initial public offering in the U.S. In the first minutes of trading, share price nearly doubled, with investors eager to grab a piece of the pie. But any way you slice it, hedge funds and risk go hand in hand.

“Let’s keep in mind what we’re talking about,” said David Friedland, President of the Hedge Fund Association. “Investors are buying into the management company of the hedge fund… as opposed to buying shares of the actual hedge fund."

In other words, this IPO allows investors to benefit from the fees collected from the management of a hedge fund. It’s a big deal, because investors often cite these high fees as the main reason they avoid hedge funds. “Here’s an opportunity to actually profit from that,” Friedland added.

However, hedge funds present more risk than people realize. “If you’re putting money in a hedge fund you’re speculating, not investing,” argued Chris Whalen, Managing Director at Institutional Risk Analytics. (Investment is the deployment capital with a reasonable expectation of getting your money back, plus a little on top.)

Another challenge is transparency. Hedge funds seem to have a penchant for secrecy. "Just imagine yourself as an equity analyst trying to follow this company,” added Whalen. "Nothing in their financials are going to tell you anything. You’d have to follow the principals around every day to get a sense of how this company is going to perform.”

Both Friedland and Whalen agree that you should do your homework before putting money in any company. “One needs to be aware of the diversification of the product,” explained Friedland. “A small hedge fund with one single fund might be far more risky than a more diversified firm that has a variety of different products. Fortress has a multitude of different funds.”

How will this go down in history? “ I think you’re going to see more investments like this” predicted Chris Whalen. “It’s part of the evolution of hedge funds as investment vehicles.”

“We’ve seen this in Europe,” added Friedland. “Out of the 6 IPO’s in Europe 5 were very successful. So we’re bound to see this continue.”