Secrets Of Success: Lessons and anecdotes in hedge funds

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While the markets have been tanking for the last few weeks, confirming my worst suspicions earlier in the year (expect short-term rallies, but no major rebound for a few months, I suspect), I have been taking refuge in reading another marvellous investment book.

It has long been one of my hobby horses that most investors would improve their performance significantly if they spent less time staring at screens and daily market babble, and more time reading about the history and dynamics of markets.

Hedgehogging by Barton Biggs, the book I have been reading, is primarily about the realities of hedge fund investment. I have no hesitation in saying that if you are thinking about investing in hedge funds, as most people seem to be, you cannot fail to benefit by first spending £16.99 on a copy of this book.

As well as being instructional, it is delightfully easy to read - Biggs was an English graduate before he stumbled into the investment world and was renowned during his time as head of research at Morgan Stanley for his ability to string coherent and entertaining sentences together.

What the book consists of, in essence, is a series of elegant essays about different aspects of his career in markets, which, by coincidence, begins and ends in the world of hedge funds.

In the 1960s, after coming out of the Navy, Biggs joined a broking firm, where he came to run a model portfolio for the legendary A W Jones, the man who invented the hedge fund concept in its classical formulation. Later, he ran up his own small hedge fund for a few years before joining Morgan Stanley, where he stayed for 30 years until resigning to found his own new hedge fund firm for a second time three years ago.

What you get, therefore, is a series of insights and lessons about what successful investing is about, intermingled with anecdotes about many of the best-known names in the hedge fund industry.

Although Biggs says that in some cases he has disguised the identities of those he is writing about, it is not difficult to recognise the likes of George Soros, Julian Robertson and other hedge fund legends.

What comes out of all this for the ordinary investor is, first and foremost, an overdue dose of realism about what the hedge phenomenon of the last few years is really all about. Biggs begins his story by recounting the misery of trailing round the world to a seemingly interminable circuit of investor "meat markets", where aspiring hedge fund managers pitch their story repeatedly to often deeply unattractive audiences of would-be investors.

While the rewards for those who get the money to start and make a success of hedge funds are spectacular, which is why so many professionals want to start one, the odds against success are much higher than many investors suspect.

For every hedge fund that makes the grade, there are at least two or three that fail to make a fortune for their founders or the investors. Something like 1,000 hedge funds go out of business every year, sometimes because they have blown up, but more commonly because they cannot attract enough money to justify going on, or because the principals can no longer take the stress and lifestyle required.

Hedge funds come in all shapes and sizes, and operate with a wide variety of investment strategies. As a result, their performance and risk characteristics vary enormously.

Market-neutral funds are descendants of the classical hedge fund model first devised in the 1940s by Jones (who comes across in this account as an unlikeable individual with an unhealthy interest in inside information). They are the type of fund many hedge fund investors want, since if they are run well, they promise modest but steady returns through all types of market condition. But they are amongst the hardest strategies to make work - a "tough racket" in Biggs' phrase.

"When it comes down to it," he writes, "there are half a dozen superstar investors in the world, a number of good investors and a multitude of what you might call journeymen" (albeit very well paid ones). As in all investment, therefore, you need to be realistic about what hedge funds are likely to do for you - what are the chances that you will be able to find the minority of funds that are going to perform in a way that justifies their extraordinarily high fees?

In practice, most investors outside the ranks of the hugely wealthy are confined to investing in hedge funds via a fund of funds - that is, a diversified portfolio of funds with a range of investment strategies chosen for you by a professional intermediary. That is great in theory, but allow for the fact that their returns are invariably lower than those of the funds' themselves, in part because of the additional layer of fees.

While the top fund of funds are worth having, says Biggs, amongst smaller fund of funds there are "too many dilettantes, too many laid-off investment bankers, too many former institutional salespeople, too many loser brothers-in-law setting up shops. It smells like venture capital or private equity in 1998 or 1999, just before the bubble burst".

By now you will have formed the impression, I trust, that Biggs is far from starry-eyed about his latest working environment. Elsewhere in his book, you will find some wise observations on such topics as how to spot bull and bear markets, what makes a good investor, and how one experienced professional investor approaches the "monumental task" of distilling and controlling the vast flow of information and research about the investment markets that pours into his office every day. All things to ponder during what may well be a long and sticky summer.

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