A hedge fund collapse and diversification 101: lessons to stakeholders

Abstract

Purpose

The purpose of this paper is events and analysis of present a hedge fund collapse, offer lessons to investors and hedge fund industry stakeholders and propose a possible remedy for mitigating operational risks and associated potential losses.

Design/methodology/approach

This study focused on one hedge fund case study and conducted a thorough investigation of the events that led to the collapse and eventual filing of the Securities and Exchange Commission (SEC) complaint. All articles and publications used for this research are available in the public domain and accessible.

Findings

Wood River Capital Management had concentrated the portfolios of its two hedge funds into one stock, EndWave Corp. Fund Manager violated terms of offering memorandum. Investors were not made aware of and did not discover the operational risks. Stock price of EndWave plummeted. There was no independent oversight over the funds. The values of the two funds dropped significantly. Investors attempted to redeem but the funds were not liquid. The SEC filed a complaint. Mr Whittier was sentenced for three years in jail.

Research limitations/implications

It is an analysis of US-based hedge fund, not an empirical paper. The article presents critical analysis and offers many valuable lessons to hedge fund industry stakeholders.

Practical implications

This paper helps investors in terms of identifying a hedge fund’s operational risks and conducting more effective due diligence while vetting a hedge fund. This could potentially save investors and constituents billions of dollars, by avoiding potential hedge fund collapses. This paper suggests that the scope of fiduciary duty be expanded to cover hedge fund industry vendors.

Originality/value

Thorough research of a hedge fund that collapsed because of poor investment decisions, not self-enrichment at expense of fund investors. This paper provides lessons to investors in terms of identifying a hedge fund’s critical operational risks and conducting value preserving due diligence. This could potentially save hedge funds investors billions of dollars, by avoiding potential hedge fund collapses. This paper recommends that the scope of fiduciary duty be expanded to cover hedge fund industry vendors.

Citation

Muhtaseb, M.R. (2021), "A hedge fund collapse and diversification 101: lessons to stakeholders", Journal of Financial Crime, Vol. 28 No. 3, pp. 774-783. https://doi.org/10.1108/JFC-09-2020-0198