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Thursday October 06 2022
They're Hedge Fund Investors -- And Proud of It

Miami Herald  November 23, 1998

by The Miami Herald


      In recent months, few international industries have received as much coverage -- for better or worse -- as hedge funds, those secretive, little-understood investment organizations that make headlines about the time they collapse.

      But enough is enough, complains David R. Friedland, as he sits in his Aventura office. He's the director of Magnum U.S. Investments, the American branch of the Magnum Group, a South Africa-founded hedge fund organization quickly gaining an international profile.


      Much of the press has focused on high-risk firms like Long-Term Capital Management, a Greenwich, Conn., hedge fund mowed down by risky investments and reckless management.


      Ironically, Long-Term was founded by two Nobel laureates and, like most hedge funds, was a haven for the very rich -- some of the wealthiest men on Wall Street.


      "The term hedge fund has been so misused because of Long-Term Capital," Friedland says. "It's like saying all animals are crocodiles."


Swimming With Sharks


      Perhaps. But even Friedland acknowledges that hedge funds occasionally swim with the sharks. In an odd sense, that's part of their charm.


      And like other water-borne predators, they do much of their work beneath the surface, out of easy view. Because hedge funds are only lightly regulated by U.S. agencies, and since much of their actual money management is done offshore, they're the wild card in the investment world.


      Mutual funds may try to match the S&P 500 by investing in solid, easy-to-get-a-grip-on stocks and bonds. Hedge funds are more likely to put money in such arcane investments as Azerbaijan real estate and Russian bonds. They're also big buyers of the complicated contracts known as derivatives.


      And unlike most mutual funds, they can borrow money to make investments and also engage in short-selling -- a method of stock trading where the investor is betting the price will fall rather than rise.


      "A huge universe of things are being called hedge funds," says Friedland. "That's why it's important for investors to do their due diligence."


Born of a Crash


      For all the recent talk of volatility and risk with hedge funds, it was, ironically, convulsions in the American stock market that led to the creation of Magnum.


      In the 1980s, Friedland's father, Dion, had sold his South African retail chain and was enjoying the perks of a booming market.


      But in October 1987, while he vacationed in Australia, he awoke to discover that half his net worth had been wiped out in the infamous Black Monday crash.


      Alarmed, he converted his stock holdings into hedge fund investments -- and watched them soar. Between 1988 and 1993, they grew almost 50 percent annually.


      He then, at the behest of friends, decided to launch Magnum. Today, it has roughly half a billion dollars under investment. The organization has corporate offices in Johannesburg, South Africa, and the money management is all done off-shore, mostly in Nassau and the Cayman Islands.


      Magnum's funds fall into the category of so-called "fund of funds." That is, they take the money from hedge fund investors and put it in a variety of hedge funds.


      It's similar, in concept, to the way mutual funds take money and put it in a diverse portfolio of stocks that, individually, few could afford.


Risky? Au Contraire


      And what about those risky investments? Friedland counters that, in reality, hedge funds' complicated portfolios actually reduce shareholder risk. For instance, if the stock market declines, pretty much all mutual funds that invest in equities will drop as well.


      But hedge funds have more dexterity, he argues. "Mutual funds are like cars without brakes," he said. "Hedge funds have brakes."


      He adds: "Mutual funds can't go short. They can go into cash or bonds, but they'll get fired [for going short]. Hedge funds can get into derivatives. They're the bad D-word, but if you know how to use them you can insure your portfolio."


      Experts say the concept behind hedge funds isn't exactly new. For years, traders have been able to buy futures and options contracts on a wide variety of products, from stocks to pork bellies. They give the purchaser rights to purchase or sell the product at a set price in the future, no matter what the market price is at the time.


      It can protect investors against wild price swings. At the same time, hedging has its risks. For instance, a contract to buy a good at $1 is clearly a bad investment if the market price should fall to 50 cents.


Rapid Growth


      Still, there's no question the hedge fund industry has undergone rapid growth in recent years as new financial instruments were developed -- interest rate futures are an example -- and technology aided the free flow of capital around the world.


      "They've been around since the 1950s, but in the last 10 years, like mutual funds, they've exploded," said Mark Boucher, author of The Hedge Fund Edge (John Wiley, $59.95).


      Hedge funds stay mostly offshore, he added, because U.S. regulatory costs are prohibitively high. A typical fund would spend about $250,000 on fees annually with the Securities and Exchange Commission, while the similar cost in the Cayman Islands, a favored haven, is one-tenth that. (At the same time, investors could be even more at risk without SEC regulation.)


      In addition, well-heeled investors like the adroitness that hedge funds have on placing, and shifting, assets. "We sort of over-regulated mutual funds," Boucher said. "Most people would like a manager to decide which stocks are good or bad, but the SEC has taken that authority away."


      Indeed, hedge fund managers have an almost unbelievable amount of autonomy in picking investments. While mutual funds that mimic the S&P 500 will all have roughly equal returns, even hedge funds that invest in similar products, such as global bonds, can have wildly different yields, depending on which instruments they pick, how much money they borrow against the portfolio and what type of "insurance," in the form of derivative contracts, they purchase.


      "Usually, the manager is paid a percentage of profit," Boucher said. In some cases, hedge fund managers get to keep 20 percent of a fund's earnings, for instance. "He doesn't get paid unless he makes money."


Another Risk


      Besides bad investments, however, another risk to investors is lack of liquidity. It's possible for a hedge fund to make an investment that, though technically still valuable, can't be sold at the moment. As a result, most hedge funds limit withdrawal opportunities.


      Domestically, just two of Magnum's 18 funds-of-funds are based in the United States. The funds require a minimum $100,000 investment and the investors must be certified. That's code for a net worth of $1 million or annual income of $250,000.


      Meanwhile, the Miami office is an important cog in this far-flung international business, Friedland said.


      For instance, Magnum is providing consulting services to financial institutions and other organizations investigating whether to start up in-house hedge funds for certain clients. It's what Friedland calls the private label business.


      Also, Magnum sometimes provides seed money to managers wanting to set up a hedge fund.


      While Aventura is better known for its namesake mall than as a center for global commerce, Friedland said he has no complaints about the location.


      "Miami is close enough to New York and Europe, and of course much of our business is done in the Bahamas," he said. "We find Miami certainly sufficient for our purposes."

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