Jim Novo, Shaina Boone, and I – engaged on a rather interesting email thread today.

It centers on a certain company claiming that it has set up the first online advertising ‘hedge fund’. I don’t want to give that company any publicity, because, in part, I have reason to suspect the veracity of their statement.

Middlemen are common. They buy inventory from a number of smaller website, bundle it together, mark it up, and sell it off to partners – be it clients or agencies – at a premium.

Google is a really huge middleman. Google uses complex algorithms to match buyers with sellers, perhaps, in a manner that is efficient than a human dealer would be able to do (alright, more efficient), but let’s be clear, it’s not a hedge fund. It doesn’t actually buy inventory itself.

Google is not a hedge fund.

Let’s go to our definitions:

A hedge fund is a private investment fund, having a largely unregulated pool of capital, whose managers can buy or sell any assets, make speculative trades on falling as well as rising assets, and participate substantially in profits from money invested.

A hedge fund works best with standardized instruments in liquid markets. Commodities – such as pork bellies, corn, cocoa or oil — are good examples. There are futures markets where sellers are seeking price stability and certainty (to offset market risk) and where buyers are looking for input price stability. Then, there’s an ecosystem of people who parcel up the risk in between, and sell it to investors who are looking to take on that risk. (Typically, hedge funds)

Mortgages, which were grouped into parcels of varying quality, and sold off by people who were looking for risk, is an example of where less-standardized commodities can end up getting standardized. And we know how well complex financial instruments perform, especially when they’re purchased by people who don’t understand what they’re buying.

Online advertising inventory is a lot like the mortgage example. You have hundreds of thousands, if not millions of sites with inventory (bless the long tail) and I imagine that it would be difficult to package it up. It might be possible to bundle them in some logical way.

It’s not that I can’t foresee owners of ad inventory, selling to a hedge fun. The long tail was virtually built for the middle man. (Alright, to be fair, the long tail – a large number of small producers – tend to sell their excess capacity to a middle man)

I just can’t foresee buyers of that ad inventory actually willing to go through a hedge fund to get at it.

How could a purchaser from an advertising hedge fund really expect in terms of performance? How could an advertising hedge fund really communicate, or promise that?

What would be the various grades of expectations? Don’t we run into direct liquidity problems? How do you control for the quality of execution though? Different types of execution causes different results. This factor, for me at least, introduces a deadly layer of complexity.

It would be like buying a derivative with 5 unknowns to it. That’s not an attractive investment vehicle. In fact, it’s a downright ugly vehicle.

These layers of complexity – of moving towards a hedge fund model – are not insurmountable. It’s just that they’re formidable.

I’m just not convinced that anybody has truly found a way to simplify it.