Expert View: Everyone wants to be a locust, but is the high life over?

Click to follow
The Independent Online

This is the time of year when Wall Street's finest forgo their glossy weekends in Palm Beach for the more understated pleasures of the Hamptons. Concern over your invite to the Red Cross Ball is replaced by worries over the Fourth of July beach party. The good life has never been better for the Manhattan elite - a point underscored by the recent listing of the annual pay for New York's top hedge fund managers. The average income of the top 25 was $251m.

This is the time of year when Wall Street's finest forgo their glossy weekends in Palm Beach for the more understated pleasures of the Hamptons. Concern over your invite to the Red Cross Ball is replaced by worries over the Fourth of July beach party. The good life has never been better for the Manhattan elite - a point underscored by the recent listing of the annual pay for New York's top hedge fund managers. The average income of the top 25 was $251m.

Leading the list is Edward Lampert, chief of ESL Investments and star of the recent Kmart bid, who paid himself more than a billion dollars, dwarfing George Soros on $305m.

The bonanza is not limited to the top of the tree. I know someone who, in only his first year of research for a hedge-fund house, has earned a bonus big enough to buy a property abroad. Any 21-year-old looking for careers advice need read no further.

What's behind this wealth is a combination of the enormous returns for successful hedge funds and their "generous" charging structures. Mr Lampert's fund has had compound growth of 25 per cent per annum since 1988. David Tepper (the ex-head of junk bonds at Goldman and also one of the golden 25) has delivered 34 per cent since 1993. No wonder they are able to use the famous "two and 20" fee formula - 2 per cent a year plus a fifth of the upside.

The consequence of all this has been a brain drain of the brightest talent in the financial community and an explosion in the number of hedge funds. In the US, some 8,000 operate at present and assets worldwide are around the trillion-dollar mark. Two fifths of these funds have opened in the past four years alone.

Their power to move markets is considerable, especially as their leveraged positions increase volumes. I'm told that one guy on the list, Kenneth Griffin (earning $240m a year), now represents 1 per cent of the entire volume on New York, London and Tokyo. Take this together with the funds' high remuneration, and consequent willingness to sack management, and you can see why they attract attention. The high-profile ousting of the chief at Deutsche Börse has led to a debate in Germany over how to control the "locusts".

Can the power of this clan continue?

The conversations in Palm Beach this spring added spice, thanks to one local "locust" who seems to have disappeared with a lot of people's money. His technique was to invite punters to watch him trade, inevitably making a mint. The "poor" clients always wrote a cheque on the spot, one of them for $20m.

Alerted by this fraud and others, and the very high failure rate among hedge funds, the regulators are finally acting. In the UK, a wide-ranging review is under way; in the US, most funds now have to register with the Securities and Exchange Commission and publish audited numbers. SEC chairman William Donaldson recently warned of a disaster if funds were not more closely monitored.

More serious for the industry is the question of whether exceptional returns can be maintained. The early hedge-fund pioneers, like Alfred Winslow Jones in the Fifties, made their money by using new investment techniques. Gifted individuals used them to spot market anomalies.

The problem is that the more gifted individuals there are who are all trying to do the same thing, the harder it gets to achieve high performance. Hennessee Group, a New York consulting firm, calculates that the average fund was up just 8.3 per cent last year, and that probably excludes the failures. Take into account the "two and 20" fee formula, and investors might ask, "Why bother?"

Locusts, enjoy your beach houses while you can.

christopher.walker@tiscali.co.uk

Comments