You know the world has changed when the boss of one of Europe’s leading hedge funds tells you that he no longer wants his firm to be known as a hedge fund, but in future wants to be considered a plain old fund manager. It reminds me of the aftermath of the internet bubble when many technology firms dropped the “dotcom” tag from their name. Something that had seemed a guarantee of improbable valuations and instant riches suddenly became a millstone around their necks. To investors, ‘dotcom’ no longer suggested exciting, innovative and dynamic, but was taken to mean insubstantial, fly-by-night and faddish.
Clearly the hedge-fund industry is heading for an almighty shake-out. Emmanuel Roman, the co-chief executive of GLG, one of the world’s biggest hedge-fund groups, has said he reckons a third of the world’s 9,000 hedge funds could disappear. That may prove an understatement. Over the last two months, almost everything that could go wrong has gone wrong for hedge funds. The most volatile markets in living memory, short-selling bans around the world that forced funds to unwind positions at huge losses, a funding squeeze by investment banks that forced funds to dump assets into falling markets, massive redemptions by investors that forced funds to sell yet more assets to raise cash. And, last week, the disastrous news that Porsche had increased its stake in VW – a move estimated to cost hedge funds $20bn.
As things stand, the industry’s claim to offer superior performance to traditional asset managers – its usual justification for high fees – looks threadbare. Sure, the average fund is down 15% this year, compared to losses of around 40% in global stockmarkets. But that’s a far cry from the absolute returns the industry used to promise. And, as Dr Harry Kat of Cass Business School has pointed out, these returns should be adjusted for risks taken. Unlike traditional asset managers, hedge funds use various strategies to reduce risk, including selling short. That’s why they tended to underperform markets during the boom. But on a risk-adjusted basis, a basket of hedge funds has performed no better than a tracker fund – and at a far higher cost.
Worse, some hedge funds are now refusing to let investors get their cash out. Those with large concentrations of illiquid assets – a category that has widened dramatically over the last year as a succession of markets have virtually closed – argue that they need to restrict redemptions to protect investors who stay behind from being left exposed to all the toxic junk. The fact that these restrictions tend to be accompanied by offers to cut fees will provide scant consolation to investors who have found that they can’t get their hands on their cash when they most need it.
But I don’t think hedge funds are about to disappear. A handful of funds have performed very well during the crisis. Even now, new funds are still being launched as investors try to capitalise on opportunities created by the crisis. That will play a role in helping markets find a floor. There’s also a lot of pension fund money that was invested in hedge funds at the top of the boom. Given the glacial speed at which the pension industry moves, that money won’t go anywhere. But the industry has to adapt. Some strategies will have to be abandoned, leverage reduced and fees cut. In other words, hedge funds won’t just start calling themselves fund managers, but will have to start behaving more like them too.
Obama may do more harm than good
Barack Obama’s election is a defining moment in US history. But will it prove a turning point for the American economy? Expectations are already riding ludicrously high that he will be a new Franklin Roosevelt, capable of lifting the US economy through soaring oratory and deft government action. But fine words have never buttered too many parsnips and Obama arguably faces more constraints on his freedom of manoeuvre than Roosevelt. In an era of global free movement of capital, there’s a limit to how much the deeply indebted American government can continue to borrow with out triggering a disastrous run on the US dollar. Nor will it be easy for Obama to repeat Roosevelt’s success in halting the slide in the housing market by using government initiative to extend mortgage terms. The average mortgage was only for five years in the 1930s compared to 25 today – anyone for a 40-year loan?
More important than any good Obama may do is his capacity to do harm. Nobody who has read his book The Audacity of Hopewill be in any doubt that Obama is a man of the left, whose allegiances are with the unions. The most worrying aspect of his presidential campaign was his regular lapses into protectionist rhetoric. As the US economy slides, the pressure from his political base will be intense. We had better hope he is strong enough to resist – or his election will mark an even bigger turning point for the world than anyone had bargained on.
• Simon Nixon is the author of Credit Crunch: How Safe is Your Money? Priced £5.99, www.pocketissue.com.