Hedge funds aren't casino capitalists. They're parasite capitalists

Outlook

Adair Turner, former chairman of the FSA (Getty)

Adair Turner coined a neat phrase for many of the banking industry’s activities during the financial crisis. In a biting critique he opined that they were “socially useless”.

He was right. But it’s not just banking at which his criticism could be aimed. Consider the bastard child of investment banking and asset management: the hedge fund industry. It is a place where a portion of the elite of both have found homes. Multiple homes, in fact, funded by salary packages which make even the dizzying rewards on offer at the height of the big investment banks’ insanity look modest.

According to a list published by Institutional Investor’s Alpha magazine, the top 25 collectively gorged upon $11.62bn (£7.6bn) in 2014. Their bumper paydays came in a year when the industry produced returns averaging in the low single digits, even though the S&P 500 stock market index – the most reliable US benchmark – would have produced nearly 14 per cent in dollar terms had you tracked it. The New York Times reports that just half of the top 10 earners managed to beat it.

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These massive rewards for mediocre performance were in part due to the industry’s structure: typically managers skim 2 per cent of their investors’ funds every year and 20 per cent of their profits. So when they do well the rewards are staggering. When they do less well the rewards are staggering. Just a bit less staggering.

It might not matter so much if what these funds did was socially useful. But it is not.

It is true that some provide a certain Darwinian screening process by attacking under-performing companies and their complacent boards. Elliott Advisors’ assault on Alliance Trust is an example that may ultimately prove to be of benefit to a legion of small investors.

However, for every Alliance Trust there is an ABN Amro. Activist funds delivered the Dutch bank to a consortium made up of Royal Bank of Scotland, Fortis and Banco Santander in a transaction which left only the latter unscathed and the taxpayers of three countries to pick up the pieces.

The activists also represent only a small sub-group within the hedge fund industry. Much of which does what serious punters do during the Cheltenham Festival: they make bets. Not blind gambles, by any means – they study the form. Their bets are sophisticated, complex trades, often guided by programmes cooked up by the best computer science graduates the American university system can offer. But they are bets all the same.

Katherine Garrett-Cox of Alliance Trust (EPA)

Hedge funds are about as far removed from long term investors, as it is possible to get. They are not so much casino capitalists as parasites on the back of capitalism and, as anyone contemplating a trip into a malarial zone should know, parasites are dangerous. So this is a sector that merits very careful scrutiny. Is it getting it?

There is more regulation now than there was in the industry’s infancy, but that’s not saying a great deal. Much of the watchdogs’ attention and energy remains focused on the banking industry.

Meanwhile superstar hedge fund managers are increasingly deploying their wealth to buy influence in the political arena. The banking industry did this with great success in the 2000s. The pay off was the disastrous “light touch” regulation that prevailed at the time.

Mercifully that has changed, and it is unlikely that the next crisis will vent forth from the banks. But the hedge fund industry? It’s certainly a candidate. Before the banking crisis, one of its members, Long-Term Capital Management, became so systemically important that its collapse very nearly dragged the financial system down with it. We should remember that. One or two bad bets and this “industry” could yet cost us all far more than merely a few inflated fees paid over by credulous pension funds.