2007: Crazy Happens, Part 1

Crazy situations occasionally crop up in the financial markets, but they are always arbitraged out by market forces in the long term. Accordingly, I expect 2007 to be the year in which the worm turns for the hedge fund world. It might end with a bang -- with the implosion of a large, well-respected fund. Or it might end with a series of whimpers as investors begin to get wise to the fact that it's silly to pay premium prices for mediocre performance and/or dressed-up beta machines.

Either way, I expect sometime in 2007 to see CNBC reporters chasing some unlucky hedge fund manager down Park Avenue, asking him to explain the disparity between his pay package and the returns of his funds' investors. With an increasing pool of pension fund money being thrown into hedge funds, I expect this scene to include a montage comparing the manager's Croesian lifestyle with the financial situation of the poor retiree whose retirement was invested in a failed hedge fund through his pension plan. As our own Doug Kass (an esteemed hedge fund veteran himself) likes to say, "Sic transit gloria."

There's more crazy ahead, too. Check back for Part 2 of this column.