QuoteReplyTopic: Scam of Hedge Funds exposed Posted: 23-May-2008 at 06:37
SPEAKING
FREELY Hedge funds: Playing dice with the
universe By Julian
Delasantellis
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In every decade,
certain socio-cultural archetypes arise to become
the avatars of their time. In the 1950s, there was
the corporate "organization man" in his gray
flannel suit; in the '60s, the tie-dyed
flower-power hippie. In the '70s, there was the
polyester-leisure-suited big-lapeled "est"
sensitivity trainer, and in the '80s, it would
have been the Hugo Boss-wearing avaricious
corporate raider. In the '90s, we had the
perpetually casual-Friday-looking 'Net
entrepreneur.
And for this decade? It can
be none other than the international
hedge-fund manager, who
"bestrides the world like a colossus" (as William
Shakespeare's Cassius described Julius Caesar just
before assassinating him), from offices looking
out over Long Island Sound in Greenwich,
Connecticut.
But has pride come before a
very big fall? Recent events in the financial
markets suggest that the answer could be yes.
On the real-estate pages of the New York
Times, any story about the latest outrageous
selling price of some co-op on the Upper West
Side, or on the beach in St Barts, or the slopes
of Vail is bound to have some reference to a hot
hedge-fund manager as the purchaser. A new
off-Broadway play, Burleigh Grime$,
celebrates the wild ways of the title character, a
hedge-fund manager who, in one of his more
legitimate profit-making schemes, has dead fish
dumped on the beaches of California to try to
profit from an El Nino market panic.
Perhaps most cheeky of all, early last
month, a manor estate just north of London became
the venue for "Hedgestock", a psychedelic
'60s-themed hedge-fund networking event, complete
with groovily painted Volkswagen vans, and
millionaire hedge-fund managers dressing as
penniless tie-dyed hippies. In contrast to the
original Woodstock (whose famous moniker of "three
days of peace, love and music" was morphed into
Hedgestock's "three days of peace, love and
money"), where commerce was limited to trading in
home-made jug wine and bad grass, the Financial
Times reported that attendees at Hedgestock had to
be satisfied with equally intoxicating Moet and
Breitlings.
As plastic surgery makes the
rich look younger to the world, maybe this is the
next big thing: pompous fantasy charades that make
the world look younger to the rich.
Starting with the tax cuts by US president
Ronald Reagan of 1981, and especially after the
near-worldwide evaporation of socialism in 1989,
the regulatory, budgetary, and especially tax
policies of the major capitalist democracies began
unequivocally to favor the rich. This meant that
greater and greater pools of free capital, once
spread more or less evenly in smallish amounts
among the broad middle classes, began to be
concentrated in fewer and fewer hands of those at
the very top of the income pyramid. This process
barely slowed with the election of
center/left-wing governments in the US in 1992,
Australia in 1993, Britain in 1997, and Germany in
1998, and it continued after the US victory of
George W Bush in 2000, and the passage and
implementation of tax cuts heavily skewed to the
rich by his administration in 2000-01.
This overabundance of capital presented a
problem for the rich. What were they supposed to
do with all the new money? Much of it went into
mindless consumption of luxury goods, such as
those offered by the Paris-based company LVHM.
Created in 1987 by the agglomeration of
luxury-goods purveyors Louis Vuitton, Moet and
Hennessy, its stock rose almost sixfold from 1994
to the market top in 2000. Now having grown to
encompass such further luxury brand names as
Tag-Heuer, Donna Karan, Fendi, Givenchy and
Guerlain, the company reported revenue of almost
US$17 billion in 2005, rather impressive
considering that amounts to 42% of world software
leader Microsoft's $39 billion worldwide 2005
revenue.
But even the elite can only spend
so much, and that left a lot of unused cash left
over that had to be put to work, had to be
invested. It was then that hedge funds came on the
scene.
Just because the rich had earned or
inherited the money didn't necessarily mean they
had the investment skills to grow it. They wanted
a surer thing than just buying and holding GM or
some other common stock, and they also wanted
something a lot more aggressive than the average
tightly regulated mutual fund.
"Hedge
fund" is simply a fancy name for a
high-initial-investment limited partnership. In
contrast to mutual funds, where an account can be
opened with as little as $500, starting
investments in hedge funds are frequently in the
$1-million-to-$10 million range; thus their status
as investment vehicles to the very upper classes
(when pressed to defend their social utility as
institutions that make the very rich even richer,
the funds say that university endowments or public
pension funds are also their customers, although
these are but a small minority of the industry's
customer base).
Also very much in contrast
to mutual funds, hedge funds are for the most part
unregulated as to the investment or, more
accurately, speculation choices they can make.
Mutual-fund managers are usually highly
constrained as to their possible investment
options. The mutual fund may be restricted by
charter to invest only in large capitalization
stocks, Treasury bills, or corporate bonds, but
the hedge-fund manager has unlimited license to
invest in stocks, bonds, countries, commodities,
parcels of real estate, or anything else. The
hedge-fund manager also has unlimited license
either to buy the investment, in hopes that he/she
will be able to sell it later at a higher price,
or "short" the investment, hoping to profit from a
decline in price.
In today's financial
world, hedge funds are all the rage. Although
there are no real statistics (a big appeal of
hedge funds is their reticence; although most
operate out of such places as Greenwich, almost
all are registered offshore, about half in
tax-friendly havens such as the Cayman Islands)
detailing the actual or aggregate size or the
world's hedge funds, Institutional Investor
magazine estimates the worldwide total of
hedge-fund assets under management (AUM) at more
than $1 trillion.
To illustrate the
magnitude of the industry, if hedge funds were a
country and the AUM represented a nation's gross
domestic product (GDP), it would rank eighth in
the world, according to the World Bank, just
behind Italy and ahead of Spain. Since most
hedge-fund strategies involve substantial
borrowing, using AUM as, say, 5% collateral for
positions up to 20 times the actual cash on hand,
multiplying the AUM times 20 gives you a potential
hedge-fund-market impact just about the same size
as the United States' GDP.
Hedge-fund
managers, mostly recruited from concerns such as
brokerages and investment banks, are far and away
the most generously paid players in the
money-management game. This is because, on top of
the standard base "salary" hedge-fund mangers
earn, usually comprising up to 5% of total AUM
(meaning that on the day the hedge-fund investor
hands his money over, he starts 5% in the hole),
the hedge-fund charters usually include managers
taking home substantial portions, usually around
20-50%, of the yearly total profits the manager
earns for the clients. Thus, since successful
hedge-fund strategies almost always include
substantial borrowing to produce huge returns, it
is not surprising that Institutional Investor
reported in 2005 that the average salary for top
hedge-fund managers was $363 million; the reputed
top earner, James Simons, of Renaissance
Technologies Corp, is reported to have taken home
$1.5 billion in 2005.
So hedge-fund
managers get the compensation, and the
accompanying world stature bordering on adulation,
of modern-day Uebermenschen. Do they
deserve it? Are their investment strategies and
techniques so breathtakingly advanced that they
deserve to be worshipped as the new century's
reigning deities?
Maybe. Maybe not.
At first, back in the late 1980s and early
'90s, hedge-fund managers did have a few new
tricks up their sleeves. Chief among them was a
tactic that was not really all that new, for there
are records of it being done as far back as the
rice-futures markets of ancient China.
That tactic was arbitrage, the
simultaneous buying of an asset cheap in one
place, and selling it higher for a profit
someplace else. If, say, your computer is saying
that gold is trading for $400 an ounce in New York
and $400.25 in London, you put two simultaneous
orders in; one to buy an ounce in New York, and
another to sell in London.
Excluding
commissions, and the fact that you almost never
get the price for a trade that the computer
monitor says you will, you will earn 25 whole
cents on this trade. However, if you can borrow,
say, $1 billion for this effort, your take for a
minute or two of this work could be up to
$250,000. Do this two or three times an hour, for
250 trading days a year, and it adds up to real
money.
But if your computer is tempting
you with this profit, others are doing the same
for other hedge-fund managers. If everybody's
buying in New York and selling in London,
eventually the price will rise in New York and
fall in London, erasing the profit potential.
Somehow, a new hedge-fund strategy had to be
found.
The new strategy wasn't all that
new. It was speculation, the simple buying of a
commodity or asset in the hope its value will
rise. For average investors, this can be a rather
risky strategy. More than 30 years ago, economists
Burton Malkiel and Eugene Fama put together what
came to be known as the Efficient Markets Theory,
which stated that individual investors cannot
outperform market averages for any extended period
of time.
But if you're speculating with
$500 million instead of $5,000, you get advantages
that the average guy sitting at the kitchen table
with a desk calculator and the stock tables of the
Wall Street Journal will never have.
Through painful experience, armies know
that you can't march soldiers across a bridge in
formation, for the force of all those feet
striking the bridge deck simultaneously can
reinforce the natural vibrations of the bridge
with each step, causing the bridge to collapse.
It's the same with investing. Get a lot of players
all doing the same thing, putting in huge orders
to buy or sell the same instrument at about the
same time, and you can move the price of that
instrument tremendously in a short time. Those fat
bonuses rise along with the inflated asset paper
values, and as long as there are always new
buyers, as long as nobody sells, everybody's
happy.
Then May 11 of this year came
along. People started selling.
During the
first days of heavy market decline, Fox News
attributed the selling to what it called
"traitors" who leaked the news of the National
Security Agency's latest phone-surveillance scheme
to the media. Those who still had some connection
to the reality-based community had another
explanation.
With hedge funds needing to
borrow huge amounts of money to finance their
trades, the hedge-fund managers discovered a neat
trick. Why borrow in US dollars and pay high US
rates (the current US prime rate is 8%), when you
can borrow in Japanese yen and convert the
proceeds to dollars, or any currency you want?
Ever since 1999 yen interest rates have hovered
around 0%, as the Bank of Japan desperately tried
to pull the economy out of a seemingly unending
recession that started with the crash of the
Japanese stock market in 1989.
This
maneuver, called the "carry trade", works great -
unless either Japanese interest rates or the yen
rise in value, for that would eat up the trades'
profits for the hedge funds. When the yen did rise
to 110 to the US dollar, and fears of rising
Japanese interest rates spread through the market,
hedge funds acted to protect their profits by
selling massive amounts of gold, oil, steel, and
developing-country equities - all the stuff that
had risen so strongly before as they purchased it.
On June 1 the European Central Bank (ECB)
warned of the risks to market stability from what
it called the "correlation of hedge-fund returns".
If all the hedge funds are doing the same thing -
such as placing huge leveraged bets on the Indian
stock market, a major casualty of the post-May 11
global selloff - then all their returns will be
"correlated" or, in non-economist terms, similar.
ECB vice president Lucas Papademos stated: "The
increasingly similar positioning of individual
hedge funds ... is another major risk for
financial stability."
It has happened
before. In September 1998, one of the top hedge
funds in the world was Long Term Capital
Management (LTCM), which had on its board Nobel
Prize for Economics winners Robert Merton and
Myron Scholes. Unfortunately, the shining stature
of Merton and Scholes apparently blinded the
funds' investors to the risks LTCM was actually
taking. When the firm realized that the massive
bets it had made in the global bond markets were
going horribly against it, the fund was looking at
$4.6 billion in losses, many times its capital
base. The New York Federal Reserve, fearing that
an LTCM bankruptcy could initiate a cascading
series of bankruptcies among the big banks that
comprised LTCM's creditors, then the creditors'
creditors, etc, stepped in to arrange an emergency
bailout of LTCM.
In the eight years since
the LTCM crisis, with the proportion of income in
the developed capitalist democracies remaining
heavily skewed toward the upper classes, the
concomitant amount of global wealth controlled by
hedge funds has grown tremendously. With all of
them investing similarly, the risks of the market
turning against their positions, resulting in a
tremendous destruction of global capital
liquidity, have also grown apace.
The result? We are all like
hapless ancients, trembling before the gods
playing dice on Mount Olympus, knowing that we are
powerless to affect the results that will so
greatly affect our lives and destinies. As they
might have said at Hedgestock:"Bummer!" Julian
Delasantellis is a management consultant,
private investor and professor of international
business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
(Copyright 2006 Julian Delasantellis.)
The beginning of a revolution is in reality the end of a belief - Le Bon
Destroy first and construction will look after itself - Mao
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