Why hedge funds will be even more risky in the next financial crisis
Posted on 26 June 2011 with 2 comments from readers
If you read the conclusion of the recently published history of hedge funds, ‘More Money than God’ by Sebastian Mallaby then you are invited to believe that world governments should be promoting hedge funds and leaving them to their happy business of taking the risk out of financial markets.
The subtext is a message that the global financial crisis of 2008 would have been much worse without the hedge funds. It reminds me of the biographies of British publisher Robert Maxwell: read the one by his staffer Joe Haines and the man is a saint while Tom Bower paints him as a sinner in a class of his own.
Writing your own history
So powerful have hedge funds become that the second version of their history has yet to be written. Mr Mallaby’s well written and researched volume is a start, but different conclusions can already be drawn from the same story.
The hedge fund phenomenon – huge largely unregulated investment funds able to go short as well as go long and raise massive debt – is a part of the global borrowing crisis that bedevils the world today, not a solution to it. That these devils saw an opportunity to borrow and profit massively from it is just one part of this tale.
The other side is the losses taken by their clients. The 1,500 funds that failed out of more than 8,000 before the global financial crisis lost their entire capital. So you have to balance the risk of losing everything against the rather impressive looking average performance of the sector in that same global financial crisis.
That is also the risk in the next crisis. What happens if even more of the rocket scientists have got their calculations wrong this time? The trouble is that the risk-reward for the fund managers staying invested is always far more attractive than giving up, although some do reduce the size of their funds from time to time and many have personal wealth tied up in them.
In truth it just should not be possible for individuals to leverage up to such an extent to place market changing bets on the directions of global markets. The hedge fund industry believes the alternative of government regulation would actually be worse for the allocation of capital, or so it says, but that case is hardly proven.
Wealth transfer
Over time successful hedge funds transfer the wealth of the world to the wealthy or their institutional benefactors. But we will see how these funds perform in the next financial crisis, the one that is brewing right now. Some wealthy folk are about to become singificantly poorer.
The course of this crisis looks extremely difficult to predict and analyze from every perspective, and having highly leveraged bets in such markets is the classic formula for complete disaster. Many hedge funds will fail, more than last time.
Naturally some hedge funds will always survive. They often move as a pack but are not entirely homogeneous. John Paulson, the famous shorter of sub-prime is sat on his pile of gold. Jim Chanos is shorting China as reality catches up with the Middle Kingdom. And no doubt Geroge Soros is doing something he is not telling anybody.
But another big shake-out is coming in the hedge fund jungle and only the very tough will survive!
2 Comments posted by readers:
All the financial instruments that have been created have only made money for the people that sell the products and the traders/market manipulators. Unit Trusts, Endowments, Pension Investment Funds, Investment Funds have never performed as per the sales promises.
Anyone UK resident and national investing in a Pension Fund is wasting their money.
State pension age will be 70 within the next 10 years and it will be means tested meaning any pensions you receive from private pensions will be deducted from any government pension you would have received getting nothing. In fact the UK government will be forcing people to put a percentage of your gross salary int oa private pension plan (authorised by the government) keeping jobs for the boys in the City of London and avoiding telling the tax payer that they would have to increase National Insurance/Tax for the shortfall the government has.
@ Comment by CashBoy – 26 June 2011
Yes and Yes. I too am very worried indeed by what is effectively a new ‘tax’ being passed off as a ‘pension savings scheme’ (compulsory!) for the masses. You are right, any savings currently being made into almost any private UK pension scheme is a waste of money. Savings in such a scheme will be used as nothing more than another income stream for the casino that is called ‘the city’.
By the time all of the fees, costs, and other ‘charges’ (not to mention tax!) have been deducted from thier ‘investment’ the saver will already be on to a looser, but then factor in inflation and the saver really will have wasted thier money. Most people, especially the young in the UK are now aware (at various degrees of understanding) of these great pension scheme scams and would never voluntarily go any where near them. In fact recent serveys have shown that a very sizable portion of the UK population not lucky enough to already be enrolled into a Government / State pension scheme, have made no ‘traditional’ investments at all in a private scheme. These young people have seen thier parents and granparents pay into schemes all thier lives only to have the provider collapse, defraud, fail to pay out in full, or otherwise run off with all or most of thier savings. These young people would not touch a private scheme with the proverbial barge pole (even if they could afford to!), hence the ‘compulsory’ element to this proposed scheme.