The Lie That Will Kill Hedge Funds

This column was originally published on RealMoney on Aug. 3 at 7:03 a.m. ET. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

It's all in the marks. Unless you have run a hedge fund, you have no idea what that means.

So I will explain it to the uninitiated.

When you run a hedge fund, you are always seeking capital. You can seek money directly from institutions or individuals, or you can do the easiest thing and seek money from those who are offering it: "fund of funds" managers who, specifically, look for managers to place other people's monies.

This cohort of investors had just gotten started in about my seventh year as a hedge fund manager, and they were always plying me with capital. I tried it for a while, but the ones I had, and they were substantial, demanded too much of my time and, I thought, forced me to make shorter-term decisions than I liked. I valued my independence too much. So I sent their money back.

Lots of people thought that was foolish. Lots wanted to grow their funds gigantically because they figured that was the way to get rich, quick. I was an idealist, and I wanted it to be a like a club where someone had to nominate you to get in. I wanted it that way because I didn't want any heat from them, and as long as I didn't seek them out, I didn't have to worry about pleasing them beyond the numbers.

Anyway, few people run money as I did. Maybe none. Most take the fund of funds' money.

Fund of funds managers interview and bracket managers into different groups: high-growth stocks, even-oriented managers, arbitrage, market-neutral, short, long, etc. They put them in buckets and measure them against others and then they go back to their real clients and say "here is the menu," or "here is what we recommend."