This excellent history of hedge funds reveals vital lessons for investors.
My holiday reading this summer included More Money Than God, by Sebastian Mallaby. Subtitled Hedge Funds and the Making of a New Elite, this new book maps out the rise of these modern-day masters of the universe.
Beginning in the late Forties and concluding early this year, Mallaby sets out the definitive history of hedge funds, their managers and their investors.
Just as the Eighties was the heyday of leveraged buyouts and the Nineties saw the glory days of private equity and the dotcom boom, the Noughties will be remembered as the decade where hedge funds came to rule financial markets.
When Alfred Winslow Jones launched his 'hedged fund' in 1948 (at the age of 48), few had any idea how important a step this would be for the investment industry. For example, the former Marxist and anti-Nazi campaigner pioneered charging performance fees (20% of gains) instead of annual management charges.
Hiding behind the hedges
Mallaby (who spent 13 years at The Economist and has been at the Washington Post since 1999) lifts the veil on the often secret, hidden world of hedge-fund managers. Many of this group prefer to keep their heads down while raking in billions for themselves and their limited partners.
Although billionaire philanthropist and international statesman George Soros is the best-known of the hedge-fund elite, Mallaby offers personal insight into a wide range of characters. He goes much further than reporting these traders' strategies, successes and failures. Thanks to his unprecedented access and interviews with the great and good, we learn about the personalities behind the trillions, their personal philosophies and charitable philanthropy.
The biggest and best in the investment jungle include the volatile, short-tempered Michael Steinhardt of Steinhardt, Fine, Berkowitz and later Steinhardt Partners, an early pioneer of block trading; and Stanley Druckenmiller, Soros's protégé at the Quantum Fund (who retired just last week).
Other stars include 'cowboy trader' Paul Tudor Jones, ex-Commodities Corporation and founder of Tudor Investment Corporation; legendary stock-picker Julian Robertson of Tiger Management; Louis Bacon of Moore Capital; chain-smoking, medal-winning mathematician and code-breaker James 'Jim' Simons of Renaissance Technologies; computer wizard David Shaw of D E Shaw; and Ken Griffin of Citadel Investment.
Although the book mostly focuses on the Greenwich, Connecticut crew, it also features some of the Mayfair set, those London-based traders who feature in the top echelons of the hedge-fund world. Naturally, renowned investor Warren Buffett also makes several appearances, usually as a saviour in times of crisis.
Hedge funds and history
As well as unveiling the titans and 'mathemagicians' at hedge funds, the book provides a comprehensive history of the booms and busts of the last 60+ years. It unveils the mind-boggling profits and catastrophic losses made and lost during historic events such as:
- the bear market in equities which began in May 1969, which hit A W Jones for six;
- the disaster that was the 1973/74 stock-market crash;
- the birth of the 'carry trade' (borrowing in low-yielding currencies to buy high-yielding assets; a speciality of Bruce Covner, ex-Commodities Corporation and founder of Caxton Associates);
- the 1985 Plaza Accord, from which George Soros got rich shorting the dollar;
- Black Monday, 19 October 1987, when the Dow Jones Industrial Index fell 22.6% in a day (netting Paul Tudor Jones a fortune);
- the fall of the Berlin Wall in 1989;
- Black Wednesday, 16 September 1992, when the pound exited the European Exchange Rate Mechanism (making Soros more than $1 billion);
- the 1994 bond-market crash, which inflicted huge injury on bond funds including Steinhardt's and proved nearly fatal for Bankers Trust;
- the 1997 currency crises in the Far East, which enriched Soros and other currency shorters;
- the collapse of the rouble and the Russian debt default, which caused
- the failure and rescue of Long-Term Capital Management in 1998.
More recently, the book covers events such as the long decline of Japanese equities since their 1989 peak; the turn-of-the-century dotcom boom and bust; the 2007-09 meltdown and bailouts; the uncovering of fraudster Bernard Madoff; and the implosion of various hedge funds, such as gas trader Amaranth in 2006.
In short, if something nasty (liquidity and leverage problems, crowded trades) or nice (the Eighties bull market) happened in world markets, then it's in More Money Than God!
Not too big to fail
Of course, 21st Century capitalism has taken a huge knock, thanks to the credit crunch, economic downturn and banking collapse. However, Mallaby warns against taking action to regulate and limit hedge funds, both in terms of their size and trading impact.
After all, he rightly points out that while bailed-out banks, brokers and insurers were 'too big to fail,' not one single hedge fund required even a penny from taxpayers to weather the financial hurricane. Instead, investors were taught a harsh lesson by Mr Market, as 1,500 hedge funds went bust or were wound up in 2008.
In summary: a must-read
Although this book stretches to 463 pages, it cracks along in an engaging manner and, unlike many rival tomes, the appendices and notes also make for fascinating reading. I have only one criticism: Mallaby fails to criticise hedge funds for their astronomically high fees, such as the baseline 2+20 structure.
In summary, this highly readable book is much more than a history of hedge funds; it's also a glimpse into the future of finance. Both new and veteran investors keen to understand markets past and present (and followers of economics, financial history, mathematics and similar subjects) should read it.
More on hedge funds from Cliff D'Arcy:
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