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Barton Biggs Talks Hedge Fund Mythology

The former Morgan Stanley strategist says not everyone seeking alpha succeeds.

After 30 years establishing himself as one of the best investment strategists in the world at

Morgan Stanley

(MS) - Get Free Report

, Barton Biggs left Wall Street to start his own hedge fund, Traxis Partners. Created three years ago, the fund now has more than $1 billion under management.

Biggs recently chronicled the challenges faced by hedge fund managers in a book called


. While writing about superstar managers such as Warren Buffett, George Soros and Julian Robertson, Biggs also reveals his own experiences dealing with the ups and downs of the market.

Biggs took the time to share some of his insights in an interview with


Your book talks about the dark side of being a hedge fund manager: the anxieties, the insecurities. Are you trying to demystify hedge funds?

Barton Biggs:

The world thinks that hedge funds are a magic road to riches for the manager and the investor. That's an illusion and a dangerous one. A lot of people start hedge funds without realizing all the slings and arrows of outrageous fortune that can afflict them and their fund. Investors are investing in hedge funds without understanding that not all hedge funds are going to succeed. It is important to demystify all that.

What do you think of managers who do not short stocks and who call themselves hedge funds?

Hedge funds that do invest long-only using leverage are not hedge funds. They are leveraged long funds. Some hedge funds are starting long-only product lines. That's different than being a long-only fund. Hedge funds are funds that use leverage to magnify their

alpha-creation and always have some longs and some shorts.

Does that apply to activists?

I don't know much about them. They can call themselves activist funds. I would not call them activist hedge funds unless they're hedging their long investments.

Talk about sentiment measures and contrary indicators.

Being a contrary investor means you believe the time to buy is when there is a lot of negative sentiment and pessimism. And you sell when there is too much optimism. Occasionally you are lucky enough to find a person who is a contrary indicator. I talk about this in the book. They can be very valuable. They tend to get most bullish at the top. I can identify them just by dealing with them, by experience. You have to figure them out.

Are you bullish right now?

Yes, I am bullish for 2006. Many of the great thinkers are bearish about the imbalances in the world economy, but I believe we have, and are going to have, at least for a while, moderate growth and moderate inflation. If so, stocks can go a lot higher, particularly in certain markets and sectors.

What are the characteristics of a great investment manager?

Great investors come in a variety of different models, but in general, clairvoyance, obsession and a massive amount of courage are useful characteristics. They have to be obsessive because they have to be crazed by competing in a game that attracts the smartest and the most obsessive people in the world.

Why do you prefer value to growth?

I've always been a value investor. Historically, value beats growth by almost 300 basis points a year. It's a complicated subject. But I also want to keep an open mind, so I am also somewhat eclectic, and there are times, like right now, when growth is so under-priced relative to value that growth is also attractive. I think that some of the big-capitalization stocks are on a relative basis reasonably attractive.

In your book, you say that being big is not always good. Does it mean that the superstar hedge funds aren't so great?

I was referring to traditional investment-management companies. Size is the enemy of performance because running a large amount of money is by definition harder than running a small amount of money. If a big manager is truly exceptional -- hedge fund or traditional -- then that manager can offset that handicap. Big funds may be very appropriate, but you have to discriminate. If you are Steve Cohen, you can run $10 billion better than most people would run $500 million.

With lower returns and high fees, is interest in the hedges bound to cool?

I don't think so because hedge funds still attract the best and brightest, so as an asset class, they are going to deliver superior performance. However, as I said before, there are no guarantees and investors should study their prospective hedge funds very intently and read the fine print in offering documents. If the story sounds too good to be true, it probably is too good to be true. The hedge fund industry will continue to grow even though the growth of assets and the number of funds have already slowed down.

Are funds of funds appropriate for investors?

For nonprofessional, moderately wealthy investors, the funds of funds make all the sense in the world. But should a major institution with the resources to the analysis use funds of funds? Probably not. It all depends on how sophisticated they are and if they have the capability of understanding 10 or 20 different hedge funds.

How does a hedge fund die?

In 99.9% of the cases, hedge funds die a slow, lingering death. That's due to either a negative performance, or a spotty performance, both up and down over a period of years. Clients of hedge funds have very little patience for indifferent performance.

What do you think of the new Securities and Exchange Commission rule?

I see it as a good thing for the industry because that basic registration is not that onerous. It does require hedge funds to abide by some generally reasonable conflict-of-interest and record-keeping rules, and it will keep out of the industry a number of small promotional hedge funds run by people that are really not qualified. has a revenue-sharing relationship with Traders' Library under which it receives a portion of the revenue from Traders' Library purchases by customers directed there from