News analysis: Defending a sinking reputation
The near-collapse of Long-Term Capital Management has tarnished the image of hedge funds
Wednesday 30 September 1998
Although most of them have been hit by the global financial crisis, 13 of the top 20 funds, including some of the biggest, are still showing gains - this in a year when a fund manager investing in UK or US stocks would have seen all their gains wiped had they performed in line with their respective indices.
Some hedge funds, such as Julian Robertson's Tiger Fund, which takes big bets on global market trends, are actually ahead on the year, and faring better than conventional fund managers.
Mr Robertson is up 30 per cent in the year to August and still 19 per cent ahead today.
PDF, a smaller fund run by the little-known Peter Putron in London, which took out sell options in Dresdner Bank shares, has performed particularly well. Dresdner lost badly as a result of Long Term Capital Management's crisis and its shares fell sharply.
While there are fears that some hedge funds are close to collapse, senior bankers involved in the Long Term Capital Management bail-out say they are too small to wreak the havoc that Long Term Capital Management would have done had it gone down.
Blair Tomlinson, a former bond dealer now observing from the sidelines at London-based consultancy Financial Risk, says: "Hedge funds, as a group, do not pose a systemic threat. There is no-one out there who compares in size or leverage to Long Term Capital Management."
But even he admits: "That does not mean somebody out there won't go under."
Paul Tudor Jones, the manager and former cotton futures trader who has done relatively well, finds it irritating to see all hedge funds tarred with the same brush.
Likewise Warren Mosler, who runs his III Opportunities stable of funds from West Palm Beach in Florida, has accused banks of actively trying to close him down.
But if hedge fund managers complain they are misunderstood they have only themselves to blame.
George Soros, the well-known hedge fund manager, famously told a Senate committee that regulators had no right to poke their nose in a business that clearly was not designed for widows and orphans.
There are three main types of hedge funds:
l Equity long-short: not unlike conventional stock-picking fund managers except that they short stocks they don't like as well as buying ones they do, and seek to balance their bets overall. Some of these have done well this year although whether that is sustainable in a long-term bear market is a moot point.
Speculators (often called global): these tend to be governed by the manager's view of global political developments and are more sensitive to political upsets such as changes in government.
They tend to invest in instruments such as currencies and bonds. This "trust me I know what I am doing school" is best exemplified by Julian Robertson's Tiger Fund and George Soros. Investors are invited to follow the cult.
Market neutral: so-called because they aim to make money irrespective of the general market movement by exploiting discrepancies between markets. Long-Term Capital Management was the biggest in the game. Its speciality was arbitrage of large holdings of fixed-income bonds. It was also the most highly leveraged of all the funds. Not surprisingly highly-leveraged fixed-income specialists are the ones most seriously at risk.
What attracts many of the brightest fund managers to hedge funds is the freedom to borrow what they like, trade what they like, and even to wear what they like. Open-necked shirts are the rule.
But the controls they chafed against in their previous jobs were there for a reason. Managers often say one thing and do another.
Hedge fund manager John Meriwether was notorious for not telling his investors what he was doing with their money.
As one wealthy individual who declined the offer to put the minimum stake of $100m into Meriwether's care says: "What scares me is that these people charge you 20 per cent if they make profits and give you nothing back when they lose money."
Bond funds played the US stock market earlier this year, and almost everyone played the yen carry game, whereby you borrow cheap yen to buy high yielding bonds elsewhere. But the big danger is not so much gearing as hubris. "People forget that in the last downturn Goldman Sachs saw its capital wiped out. These guys are only as good as their last deal. But they they all have the capacity of not living up to their reputation."
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