The rise and fall of the hedge fund empire
The $2trn hedge fund industry is not known for employing humble individuals, but its own beginnings were humble. David Walker reviews Sebastian Mallaby’s More Money Than God, a vivid description of its turbulent evolution since 1949.
In late 2008, at the height of the crisis, the seasoned hedge fund investor Sandra Manzke lost her cool speaking about the industry that she had nurtured for more than 20 years.
A prominent UK fund had hit trouble and ‘gated’ investors into funds. Manzke felt entrapped.
“They can’t lock the money up,” she said. “It’s not theirs to keep. It belongs to me and to my investors.”
When she had started in the industry, allocators went to lawyers to get a ‘letter of recommendation’ before being allowed to meet a manager. By the time she left the industry in disgust, investors were contacting lawyers to sue their manager.
The one that ‘gated’ Manzke was itself battling in court to retrieve assets trapped in Lehman Brothers. Lehman itself had gone bust just weeks earlier. Its CEO Dick Fuld had vowed to “hurt” hedge funds betting heavily against its survival, and his rant – a leading hedge fund banker damning the industry that had fed him – is near the climax of More Money Than God, Sebastian Mallaby’s biography of the hedge fund industry from its birth in 1949 to its near-death in 2009.
The Washington Post columnist describes how the largest managers, who had made “more money than God” according to a US congressman in 2008, lost fortunes just as quickly, then set about making them again.
Investors, in aggregate at least, seem not to have minded this roller coaster. In 1991, just three managers – Julian Robertson, George Soros and Michael Steinhardt – ran more than $1bn. By March 2011, database HedgeFund Intelligence recorded 330.
Mallaby describes hedge funds as “vehicles for loners and contrarians, for individualists whose ambitions are too big to fit into established financial institutions”.
One dispatched researchers to West Africa to report on “the number, length and condition of cocoa pods” so it could pre-empt and pre-trade the official reports.
Employees at the first hedge fund, run by Alfred Jones, ran to the SEC offices to read company announcements immediately, rather than await the post. Over its first 20 years, Jones made almost 5,000% for his investors.
One of Robertson’s colleagues became a representative of Avon before taking a stake in the company. For Steinhardt’s colleagues, betting against consensus was “the height of professional satisfaction”.
The main impression one gets of the best managers is that they simply work harder, think more laterally and then sometimes bet with more conviction than their long-only peers.
One US credit manager who profited in 2009 while his chosen asset class largely imploded told InvestmentEurope that his team dissects data on US mortgage lending, repayments, foreclosures and salaries, suburb by suburb. The team also drives through regions, street by street, before investing in mortgage securities.
John Paulson conducted similar legwork before his position against US sub-prime mortgages in 2005. He had to wait two years for it to go spectacularly right, becoming the industry’s most lucrative ever bet.
Once you have such insight, the industry philosophy was ‘bet big’.
Soros instructed colleague Stanley Druckenmiller to “go for the jugular” in his famed short on sterling.
But in illiquid markets, that can misfire badly.
One player at Amaranth single-handedly brought the $9bn company down in 2006. It saw 70% of more than $9bn assets vaporised inside one month.
Nick Maounis, its founder, subsequently told investors on a call: “We lost a lot of our own money this month. We lost even more of yours.”
The one shortcoming of Mallaby’s 400-pager is it shows too little of investors’ reactions to such news.
After all, investors lost their shirts on bad bets, too. Or, where managers made ‘more money than God’ by retaining just 20% of profits, investors presumably made four times more than God.
One told InvestmentEurope last month the industry’s main problem now is that managers are not taking enough risk – not that they are taking too much.
“We want managers who will put more on the table. Many are being too conservative. You want managers confident enough to back their judgment, but realise when the market tells them confidence is misplaced.”
The industry is populated by the egos that get this calculation right, but also littered with the bodies of others who misjudged to spectacular effect.