Yes, It’s High Time For A Crackdown On Hedge Funds

The  Evening Standard  –  28 May 2010

Are hedge funds the root of all evil? There were certainly times during my 12-year City career when I believed so. Indeed, I begin a chapter of my book Cityboy by expressing the hope that “when the revolution comes… it’s those hedge fund boys who’ll be first up against the wall”.

I am not alone in harbouring such hostile sentiments. The Archbishop of York referred to them as “bank robbers” and “asset strippers” and this week, despite Chancellor George Osborne’s opposition, the EU’s finance ministers voted overwhelmingly to impose tougher scrutiny and regulation on these shadowy organisations.

But before we condemn them outright perhaps we should ask ourselves what exactly hedge funds are and why they elicit such strong feelings?

While the term hedge fund covers a multitude of sins, most of them differentiate themselves from the kind of conventional funds that invest money for your pension or ISA in one or all of the following ways: They invest short-term, they take big (and hence risky) bets, they invest with money they’ve borrowed, they invest in unusual asset classes (especially favouring volatile derivatives) and, most notoriously, they take “short” positions (which make money when an asset price falls and hence “hedge” against market weakness).

If most investment funds (and the people who run them) are about as exciting as Geoffrey Boycott at the crease then these boys act more like Ian Botham would when there are two overs left to play. They love gambling big-time with the money that they’ve been given to invest and are never satisfied with the pathetic 5%-10% return most funds aim for.

These characters also trade shares like they’re going out of fashion. Whilst some boring, old firms might “turn over” their portfolio once every four years these jokers sometimes trade their entire portfolio every few weeks!

This means that a hedge fund with £1 billion under management could easily hand out more commission to stockbrokers than a conventional firm worth £50 billion. It’s no wonder that when they started growing and multiplying at the beginning of this decade they quickly became the number one clients of broking firms. Indeed, we loved them so much we soon forgot about dullards like the Prudential or Fidelity.

All our time and expense budgets were aimed at seducing these “fast and loose” firms and many investment banks even started setting up their own internal versions (something President Obama is keen to stop happening).

It is now estimated that hedge funds control around $1.5 trillion of assets globally with London-based funds running about $240 billion (80% of Europe’s total). Amazingly, about half of all the stocks traded on the London Stock Exchange are now bought or sold by hedge funds.

But why does the EU view these excitable folk as dangerous chaps who need to be controlled? Well, the problem is that these loose cannons sometimes break rules just to make sure they go home with a fat bonus at the end of each year.

When I was a stockbroker it was always the hedge fund clients who would subtly ask me over a £350 bottle of Dom Perignon if I was privy to any inside information. It was also always these comedians who would spread false rumours and manipulate markets (often working in cabals) to ensure that their bets came good.

Their naughtiness derived from the way they were paid. Hedge fund managers personally receive 20% of the outperformance their fund achieves. So, if six guys run a £1 billion fund and it goes up 30% in a year then they would split £60 million between them. Hence, one individual US hedge fund manager made $3.7 billion personally for correctly betting against the US housing market three years ago.

You may still feel that all this has got diddly squat to do with you but I’m afraid it does. Some of these scoundrels actually wanted the recent financial crisis to occur and did everything in their power to ensure it did. Hence, false rumours about the imminent bankruptcy of Halifax Bank of Scotland were spread in March 2008, causing its shares to fall 17% in just three hours. I have no doubt that certain cunning hedge fund managers had shorted HBOS’s shares prior to spreading those rumours and made a tidy profit — as they did with Lehmans and Bear Stearns etc.

Likewise numerous hedge funds have recently been betting that Greece will default on its debt, helping to massively destabilise that country and the euro.

While these gambles would only work if there was already some inherent weakness in the underlying asset those nasty critters who sought to profit from the developing financial instability have most certainly helped contribute to the financial woes we currently face.

I don’t want to pretend that all hedge fund managers are degenerate parasites with a sociopathic disregard for their fellow man that Pol Pot would be envious of. I also don’t want to pretend that without them everything would have been tickety-boo. However, I have no doubt that some of these boys are part of the problem and not part of the solution.

I also believe that closer scrutiny and tighter regulation will help control the more criminal among them while not driving all these affluent tax revenue generators away from our fair shores to Mumbai or Beijing.

Fair-playing hedge funds should welcome these EU proposals — because if the actions of some of the rotten apples among them cause the next financial crisis then maybe there really will be a revolution.