SRM, the Monaco-based hedge fund run by Jon Wood, has lost investors about half their money since its launch in 2006. In 2007 there was an estimated decline of 30% and there has been another 25%-30% fall so far this year.
Wood and his fund have become Northern Rock’s biggest shareholder. The Rock has been a key factor behind the fund’s poor performance; SRM is thought to have bought into the bank at an average share price of 250p, against the current price of around a pound. Wood is also sitting on losses from its sizeable stake in US mortgage lender, Countrywide Financial.
SRM raised $3bn from investors in 2006 at launch, with many agreeing to a five-year lock-in period. There’s little they can do except wait and hope performance turns around. But that’s life, declares one adviser who helps investors select hedge funds. “You can’t get double-digit returns without risk. You shouldn’t buy a Ferrari if you’re going to be worried about scratches when you park it in London.”
Whether SRM’s investors have bought a Ferrari or a clapped-out Lada is open to question. But while it wouldn’t be right to gloat over a hedge-fund manager’s difficulties – getting the markets right is tough at the best of times – this by no means untypical story might make us reflect a little on the strange world of hedge-fund fees. To recap, investors in SRM are charged a base fee of 1.5% (for a three-year lock-up) or 1% (for a five-year lock-up), plus a 25% fee on any gains. On the initial $3bn investment, and assuming no change in fund value, that would equate to a healthy $30m-$45m a year for the fund manager before even getting started.
Even if all the investors demand what remains of their money back as soon as they can, it’s likely SRM will have earned over $100m in the interim. And if the fund recovers and grows, performance fees could be far greater than this. This is a pretty good deal for the fund manager – so good that hedge funds have been described as a “compensation scheme dressed up as an asset class”.
But why would anyone invest in such a “heads you win, tails I lose” investment structure? When asked this, most hedge-fund marketers and advisers retreat into jargon about “alpha”, or waffle about Ferraris. And no wonder: because the reality is that failure seems no impediment to success, if that makes sense.
The list of investors who blew the lot but still get the money to have a second go gets ever longer – from John Meriwether of LTCM, to Brian Hunter of Amaranth, or even the now twice-bust Victor Niederhoffer. It’s as if a doctor who’d killed off his patients by some new medical procedure were repeatedly given a whole new list of guinea pigs to experiment on.
Fortunately, there is no longer any need for investors to buy these funds. Many of the techniques they use are now readily available, at low cost, to the retail investor. The exchange-traded fund (ETF) market offers a wide range of funds that can profit from falling indices or industry sectors, and which give investors market exposure without the cost of a fund manager. At the same time, more and more individual investors are using short selling, the traditional preserve of the hedge-fund manager, either directly or through share substitutes, such as contracts for difference (CFDs).
Ultimately, the recent boom in super-expensive hedge funds may be seen as the last gasp of the fad for active fund management. To put it simply, the price of the service is now much higher than is justified by the skill involved. Hedge funds are the most extreme, but not the only example of this.
While there will always be an active fund management sector, until fees come down there is a very strong incentive for investors to take things into their own hands. When combined with new low-cost vehicles for long-term saving, such as the self-invested personal pension (Sipp), the opportunities for doing so have never been greater.
As for the hedge funds, their millionaire managers, and their advisers and brokers, the good times are probably over.
by Paul Amery