This is not a book about picking winning trades. It is a due diligence manual for allocators, written by a fund of funds manager, on how hedge funds actually blow up: bad valuation, thin back offices, and getting too big to stay nimble.
The one idea
Hedges' argument is that hedge fund investors lose money less often from bad market calls than from bad plumbing. He walks through transparency and disclosure, operational risk, valuation practices, and the effect of fund size on returns, using a 2002 Capco study of over 100 failed funds as his backbone. The core finding he leans on: operational issues, not investment losses, were the primary or contributing cause in about half of all hedge fund failures in the study.
The book is structured as a due diligence checklist dressed up as chapters. Each one ends with a bulleted TIPS section that is meant to be lifted directly into an investor's own questionnaire: what to ask about transparency, what to ask about back-office capacity, what to ask about who signs off on a fund's pricing. The throughline is that most hedge fund disasters were visible in advance to anyone who asked the right operational questions, not just the ones about strategy and track record.
A separate strand, built on an LJH Global Investments study of 268 funds from 1995 to 2002, argues that fund size itself predicts returns: small funds outperformed, and midsize funds performed worst of all. The practical takeaway Hedges wants readers to walk away with is that the standard investor bias toward large, brand-name managers is backed by weaker data than most allocators assume.
What it actually teaches
Hedges lays out due diligence as a sequence: verify the fund will show you enough to judge it, check whether its back office can support what it claims to do, check who is actually pricing its books, then weigh its size against the strategy's capacity.
DEMAND A COMPLETED RFP
Before anything else, get a written request for proposal covering four areas: corporate overview (ownership, personnel turnover, compensation, legal history), investment strategy (origin, sources of return, risk management, performance), operational and administrative detail (reporting, NAV calculation, technology, disaster recovery), and a summary of what makes the firm distinct. Institutional investors use this document to compare managers on the same terms rather than relying on a pitch.
SEPARATE TRANSPARENCY FROM DISCLOSURE
Disclosure is a manager handing over documents. Transparency is whether you can actually understand what the manager is doing with your money after reading them. If full position-level disclosure is refused, Hedges says to fall back to summary portfolio statistics: concentration levels, long and short exposure, leverage, and liquidity, plus the top 5 to 10 positions. A separate account gives full transparency but typically needs $15 million to $20 million minimum to set up.
SCORE OPERATIONAL RISK SEPARATELY FROM INVESTMENT RISK
Split failure causes into three buckets: investment risk (the strategy itself), business risk (the firm can't sustain itself as a company), and operational risk (back-office failure, fraud, misrepresentation). In the Capco data cited, 54 percent of failed funds had identifiable operational issues, and the two most common single causes were misrepresentation of investments (41 percent of operational issues) and misappropriation of funds (30 percent). Ask directly about style drift: is the manager trading outside the stated strategy without telling investors.
CHECK WHO SIGNS OFF ON THE PRICE
Valuation problems contributed to 35 percent of the failures in the same study, and 57 percent of those valuation failures involved outright fraud or misrepresentation, versus 13 percent honest mistakes and 30 percent process failures. The fix Hedges pushes is separation of duties: the trader or portfolio manager should never be the one who finalizes a mark, and an independent third party outside the fund company should check it. Give extra scrutiny to convertible bonds, mortgage-backed securities, credit default swaps, other OTC derivatives, distressed debt, nondollar instruments, and any position large enough that it can't be sold without moving the market. Broker quotes on convertibles in one portfolio he cites varied by an average of 5 percent and as much as 20 percent between highest and lowest bid on the same issue.
WEIGH SIZE AGAINST THE STRATEGY
In the 268-fund LJH study (January 1995 to December 2001, tracked through December 2002), funds were bucketed small (under $50 million AUM), medium ($50 million to $150 million), and large (over $150 million). In long/short equity, small funds returned a mean of 2.27 percent a month against 1.39 percent for large funds, with medium funds worst at 1.19 percent. Ask where a fund sits in that range and whether it has closed to new capital, since managers who left giants like Tiger ($22 billion at peak) and Soros ($23 billion at peak) to start their own funds capped those funds at $500 million to $1 billion, far below where their prior funds topped out.
What it looks like Monday morning
A reader who takes this seriously stops treating a hedge fund pitch deck and a due diligence questionnaire as the same document. The concrete change is building an actual RFP template with the four sections Hedges names, and refusing to allocate until a manager answers all four, not just the strategy pitch.
The second change is asking two questions nobody asks by default: who signs off on this fund's monthly marks, and is that person paid based on the fund's performance. If the answer is the portfolio manager prices his own book with no independent check, that alone is grounds to walk, regardless of the track record on the page.
| Strategy | Size bucket | Mean monthly return |
|---|---|---|
| Long/Short Equity | Small (under $50M) | 2.27% |
| Long/Short Equity | Medium ($50M-$150M) | 1.19% |
| Long/Short Equity | Large (over $150M) | 1.39% |
| Market Neutral | Small (under $50M) | 1.10% |
| Market Neutral | Medium ($50M-$150M) | 0.65% |
| Market Neutral | Large (over $150M) | 0.42% |
Midsize funds underperformed both smaller and larger funds in both strategies the study tracked.
The evidence is clear. Size does impact performance.James R. Hedges IV, Hedges on Hedge Funds
Where it fails
- The core statistics are frozen at 2002 to 2003. The Capco failure study, the LJH size study, and the manager-count figures (roughly 1,000 hedge fund managers in the late 1990s growing to 6,000 by 2003) all stop before the industry's AUM roughly quadrupled and before Dodd-Frank and Form PF rewired U.S. hedge fund regulation. The regulatory chapter reads as speculation about what the SEC might eventually require, which the book treats as an open question the industry has since answered.
- Two of the five method chapters are credited to other authors and read like inserted white papers. Chapters 3 and 4 (operational risk and valuation) carry a footnote crediting Stuart Feffer and Christopher Kundro of Capco, not Hedges. The prose voice shifts noticeably from the surrounding chapters, and the content is closer to a consulting firm's research summary than an integrated argument, with the TIPS section at the end of every chapter repeating material almost verbatim from the body text.
- The size study has known bias and no update. It covers 268 funds over a single seven-year window that predates the 2008 crisis, the post-crisis wave of institutional money chasing large, brand-name managers, and the crowding of small-fund strategies that has narrowed the small-fund edge since. The book does not revisit the finding in a later edition, so a reader has no way to know from this text alone whether the small-beats-large pattern persisted.
- The due diligence bar assumes institutional resources. Separate accounts, which the book treats as a normal path to full transparency, require $15 million to $20 million minimums. Third-party risk platforms like the RiskMetrics and Measurisk systems it describes carry subscription costs the book itself says put them out of reach for individual high-net-worth investors. A reader without institutional-scale capital can read every checklist here and still be unable to execute most of it.
- The author is selling the same service he is describing. Hedges ran LJH Global Investments, a hedge fund advisory and fund of funds firm, while writing this. The RFP process, the transparency framework, and the due diligence checklists in the book describe, closely, the kind of manager-vetting service his own firm sold. The book never states this as a conflict for the reader to weigh.
Who it is for
Buy it if
You allocate to hedge funds or funds of hedge funds, or you are building an institutional due diligence process from scratch and want a ready-made questionnaire covering transparency, operational risk, and valuation red flags. It is also useful as a case-study record of how mid-2000s fund blow-ups (Lipper Convertibles, Beacon Hill, Manhattan Fund) actually failed operationally, not just strategically.
Skip it if
You are a retail investor looking for a strategy or an edge, since this book gives you neither: gives_edge and fixes_edge are both no. Skip it too if you need current hedge fund regulatory guidance, since the compliance chapter predates Dodd-Frank and Form PF by several years and no longer reflects the rules managers operate under.
As an Amazon Associate I earn from qualifying purchases. It costs you nothing extra, and it does not change what gets recommended or what the verdict says.