City & Business: Tide may be turning for investment high rollers

AT THE beginning of Liar's Poker, the William Lewis book on the glory years of Salomon Brothers, John Gutfreund strolls over to the trading desk and whispers to one of the assembled: 'One hand, one million dollars, no tears.' The chairman of one of Wall Street's largest investment banks was challenging the trader to bet a million dollars on a childish game, which involves guessing the serial number on a dollar bill. The trader, one of Salomon's best, reputedly replied; 'No John. I'd rather play for real money. Ten million dollars no tears.' Gutfreund said 'You're crazy', and declined.

The man who so cleverly outbluffed him was John Meriwether. Mr Meriwether eventually became embroiled, along with Mr Gutfreund, in the bond- rigging scandal that nearly sank Salomon, and the two were forced out. For a few years, Mr Meriwether vanished from the scene, but now he's making a comeback. He's doing so - surprise, surprise - as one of Wall Street's biggest hedge fund players. Currently he's trying to raise several billion dollars from investors to trade in complex financial instruments, using all the latest fancy computer-driven techniques. When Mr Meriwether places a bet in the world's capital markets, he gambles big - very, very big. With the promise of 30 per cent returns per annum, he already commands a considerable following.

It sounds impressive, but among hedge fund players he is by no means an exception. At the last count, there were about 800 of them with capital of around dollars 50bn ( pounds 33bn). The top five funds account for half of this. Once you include their ability to gear up with debt, their total firepower in capital markets could be as high as dollars 500bn. These are frightening large figures for largely unregulated andunsupervised institutions; it's little wonder that central bankers are increasingly concerned about their proliferation.

This weekend, banking supervisors have hedge funds high on the agenda as they assemble in Basle for one of their regular meetings. Central banks come at the problem from differing perspectives. The Continental supervisors tend to see hedge-fund players as wicked destabilising speculators, wreckers of fixed exchange rate mechanisms and destroyers of bond markets.

The Bank of England and the Federal Reserve Board on the other hand are much more tuned into and comfortable with market volatility. Their chief concern is about the risk hedge funds present to the banking system. Do bankers fully understand what they are doing when they lend money to hedge fund players? What collateral do they ask for? Do they even know who and what they are lending to, other than a bunch of whizz-kid traders? What unites all central bankers, however, is that they understand hardly anything about this relatively recent phenomenon. The little they do know is largely anecdotal. Hedge funds were said to have played a big role in driving the pound out of the ERM. They are also rumoured to have been a big factor in the bond market sell off in recent weeks. At the Bank of France and the Bundesbank, this kind of market power is seen as a bad thing per se, but somehow I doubt the hedge funds are quite as influential as claimed. Bond markets were riding for a fall in any case, and so was the ERM when it collapsed; it had become untenable.

Hardliners among the supervisors will nevertheless press for draconian action, perhaps the imposition of international restrictions that would make lending to the hedge funds much more difficult. It may well be that the high tide of the hedge fund era has in any case already been reached. All of them are finding it much more difficult to make money this year, and some of them are beginning to show quite substantial negative returns.

As our feature on George Soros shows, hedge fund investors get little, if any, protection and they have to take an awful lot on trust; there seems to be considerable scope for abuse. Mr Soros and his senior managers appear to run their vast investment empire in the manner of a small-town family business. The borders between what belongs to Mr Soros and his inner sanctum of managers on the one hand and investors on the other are blurred almost to the point of indistinction. Rules are chopped and changed in a seemingly arbitrary fashion, and Mr Soros appears to have the ability to 'reallocate' gains to himself in almost any way he chooses. I guess it's a tribute to his reputation that investors have so far been prepared to put up with what in any regulated fund would be totally unacceptable terms and practices.

You have to wonder for how much longer though. When everyone is making hay, nobody much cares about the division of spoils; investors will accept almost any terms to get in on the action. But when things change and the money doesn't roll quite as it used to . . .

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