Concentrated Hedge Funds

Bloomberg recently reported how hedge funds run by both Jon Wood and Eddie Lambert are down for the year, in part due to the concentrated nature of each fund. Wood's fund is expected to only invest in no more than 40 companies, but was recently hurt as U.K. Bank Northern Rock Pic and California mortgage company Countrywide Financial suffered losses. Lampert's fund has been hurt by its large stake in Sears Holdings, for which Lambert is chairman.

For many, both investors and managers, concentrated funds are both an opportunity to strike it rich, but also provide the potential to implode quickly. For fund managers, who are often compensated on a 2/20 setup, the potential for 20 percent of a big winner is often too tempting to ignore. If the fund implodes, management will often close up shop given that it will be difficult to get above high water marks anytime soon. Those managers that want to continue on have to worry about investor redemption, unless the fund has long-term lockup provisions in place. Even then, it may still be unattractive for high profile managers to continue on with the existing fund given that their track record may be good enough to raise fresh capital as a new fund is initiated. Yet many investors don't seem to mind, given their knowledge of the risks and track record of the manager. Many of the same investors will follower a manager as he or she closes down one fund and opens up another.