Good Morning from Asia Henry;
I have previously expressed concern about pension fund involvement in hedge fund investments. This article specifically mentions pension funds. I just cannot seem to find any reference to specific regulations that would prevent pension funds from taking highly leveraged positions vis-a-vis hedge funds. I hope those that do are investing in funds more like the one you describe that your friend runs.
Best,
Stitch
Hedge fund 'dummies' pay price
Portfolio,
By Barrie Dunstan
As a small investor, contemplate this potential proposition: your investment manager is going to borrow lots of loan money to speculate in volatile derivatives markets, you need to commit your money for three years on a no-questions-asked basis – and the fees are up to double the going rate.
Would you invest? If most small investors followed a normal, prudent approach, the obvious answer would be "no way".
But if you were a large investor with millions to invest and the investment fund just happened to be headed by former Salomon Brothers bond trader John Meriwether and had two Nobel laureates, Myron Scholes and Merton Miller, as directors, would it change your mind?
The big investors who were courted by this particular fund – the most notorious hedge fund in the business, Long-Term Capital Management – found themselves in a losing situation. Last month, it needed a $US3.6 billion ($5.8 billion) bailout, masterminded by the US Federal Reserve Board chairman, Dr Alan Greenspan.
Long-Term Capital and other hedge funds are getting the blame for many of the sharp swings in currency and bond markets, perhaps justifiably. But small investors who can ride out the swings of mood will have one consoling factor – they haven't had the losses of many larger and allegedly smarter investors. Because if average investors had been approached by Long-Term Capital to invest money, they might have had the common sense to ignore the offer. Some big investors and banks clearly didn't, and the collapse has caught some of the largest and smartest investors in the world.
Long-Term Capital was heavily borrowed – some reports suggest as much as $100 of debt for each $1 of equity. It then was investing in the most highly volatile market areas, based on the ideas of some of the smartest people in investment.
But according to US specialist newspaper Pensions & Investments, many large investors rejected investment in the hedge fund because of the terms of the investments, the high fees it charged and the lack of transparency in its reporting – all warning signs for any investment.
If you invested in the hedge fund, funds were "locked up" for three years. In reporting returns the group would not say where they had made their money, even after the fact. On top of that, its fees were 2 per cent on assets and 25 per cent of profits; more usual hedge fund fees were 1 per cent on assets and 20 per cent of profits.
However, several US pension fundshave invested in hedge funds, and such high-flying investments were also accessed by executives in leading management consultancy McKinsey & Co and big financial services group Merrill Lynch, via deferred compensation plans, Pensions & Investments reports.
All in all, it should be a chastening experience for the big, brave and previously bold investors of Wall Street, the 1990s' equivalents of the Masters of the Universe (from The Bonfire of the Vanities).
But will it be? The lesson should be, as Barron's columnist Alan Abelson put it recently: "Derivatives don't kill, dummies do."
Just as derivatives markets in their relative infancy in the late 1980s were blamed for the 1987 collapse, if the world markets deteriorate further there'll be plenty of people ready to blame the futures and options markets and say: "We told you so." The fact is that, no matter how street-smart the traders or how intelligent the university professors, an investment fund that borrows huge amounts of loan capital, backs theoretical investment plays generated by computer algorithms and then deals in the most speculative of world markets without the need to disclose its dealings is headed for disaster.
If we're lucky, the fallout will claim only the victims who deserve to go down with the leaky ship, leaving the rest of the world's markets and millions of smaller investors around the world to survive.
Meanwhile, Long-Term Capital should provide a reality check to some of the more overheated financial market speculations and Wall Street stockmarket valuations.
afr.com.au |
