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Sunday August 07 2022
Top Hedge Funds Have Taken Recent Hits With Honour

FinFund, March 2008

Leon Kok




TRAGIC that the subprime crisis and its consequences may have seemed to many, there has certainly been a funnier side to it as well. And it’s that whilst numerous national regulators and others have been gunning for tighter hedge fund regulation, the ones’ that came really unstuck are highly levered investment banks.


True, common ground does exist where investment banks operate hedge funds.


In the US hedge fund managers argue that the problem with regulation is that it’s often forced by some market event that’s invariably blamed on hedge funds. For years the assumption has been made that hedge funds would bring financial disaster. This time it would seem that the banking sector triggered it.


Looking back on 2007, there’s no doubt that hedge funds were hit by the market upheavals, but they certainly came through significantly better than the top investment bank brands.


One irony is that top hedge fund, TPG-Axon, with some US$12 billion in assets, was among those that baled Merrill Lynch out of its mess.


Closer home, one needs only to look to South African Dion Friedland’s suite of international hedge funds. His TM IndiaStar Fund has gained 244% since inception in April 2007 and gained 45% last year. His BM Greater China Asia Fund, a long/short fund, has gained 122.5% since inception in March 2004 through to the end of 2007. The largest losing month was a mere 2.4% (November 2007).


The MG Secured Debt Fund that invests in well collateralized loans backed by real estate and personal borrowers, gained 39.5% in 19 months since inception without any losing month and remains unaffected by the subprime mortgage problems and credit crisis. 


Friedland, a product of Pretoria Boys’ High School and Wits University, started the Dion’s discounting chain in SA when still in his twenties, sold out and became one of the early pioneers in the international hedge fund space. Until recently he was President of the International Hedge Fund Association.


Common belief was that hedge funds would be the most exposed when the markets turned in October last year. That has not happened to date.


Besides being highly disciplined, an important reason is that interests of hedge fund managers are mostly aligned with their clients and they therefore move a lot more quickly to reduce risk. The best hedge funds usually have strict loss limits, in many cases written into their offer documents.


A prominent London-based South African hedge fund manager told me recently that numerous investment banks in contrast were well aware of the rising risks in July and August last year, but only moved out in December with disastrous consequences.


However, I don’t wish to over-state the case for hedge funds and under-state the dangers of over-regulation. There have been some big hedge fund blow-ups during the past decade, mainly due to fraud, and there is also now a clear trend of failures due to poor performance.


More than 1 000 hedge fund firms were registered in the Caymens alone in the first six months of 2006. Approximately 80% of all hedge funds worldwide are registered there. They can’t all be good.


Some of the newer hedge funds in particular are getting themselves into trouble by investing in risky investments. For example, those specializing in collateralized debt obligations (CDOs), pools of bonds with varying levels of risk, might have become a lot more unstable if US Fed Chairman Ben Bernanke hadn’t slashed interest rates recently.


On the other hand, Merrill Lynch, the biggest generator of these, came horribly short, having been left with a large stockpile when appetite evaporated. The horrific losses resulted in CE Stan O’Neal being replaced by John Thain, former chairman of the New York Stock Exchange and a veteran of Goldman Sachs.


Perhaps the most disappointed hedge fund managers recently have been stressed debt firms that have waited anxiously for good opportunities in the previously worsening credit situation.


Compare hedge funds generally now to several leading international investment banking brand names that were disgraced last year, including Bear Sterns, Commerzbank, Credit Agricole, Goldman Sachs, Morgan Stanley, UBS and naturally Merrill.


Northern Rock, which is slightly different, is expected to cost British taxpayers more than $100 billion which my friend Martin Spring tells me is about as much as the entire annual cost of the state schools system. Not child’s play.


Plenty of blame lies with these investment banks. Innovation in credit derivatives, for instance, led to borrowers being offered loans that they could not hope to repay once initial low interests rates reset to higher ones. Many investment bank managers seemingly didn’t grasp the risks of complex securities approved by ratings agencies.


No attention here has been given to the Societe Generale issue that’s seen the French bank lose upwards of R40 billion. If ever there were an indictment of investment bank controls, it’s this. I’ll be visiting Paris later this month and will cover the issue in a future edition. Sorry, but it’s hard to believe that a rogue trader alone was involved. Embattled chairman Daniel Bouton will have to do a lot of explaining in the next few months.

The Financial Times, acknowledging the aforementioned in a recent editorial, remarked: ‘Investment Banks are fallible but not replaceable’. That's true, but hopefully it may have regulators on the hop again. Hillary Clinton, meanwhile, has signaled that she’ll attack ‘Wall Street’ if she wins the US presidential election. If the American establishment has its way, this is one reason why she won’t win.


Interesting stuff.

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