Monday, February 11, 2008
hedge funds might be resivilent compared to investment banks
--Investors handed the industry a record $200 billion of new money to manage in 2007, a year in which hedge funds also managed to return an average of just more than 10%, according to Hedge Fund Research, an industry data group. That's not bad given that markets turned volatile and nasty -- at least for big banks, most of which racked up billions of dollars in losses on U.S. subprime mortgages, structured finance and buyout loans. --With hindsight, there are convincing reasons for the hedge funds' relative resilience that should be instructive for those still looking to wrap hedge funds in red tape. --Hedge funds are focused investment businesses. They live or die by making money for investors and their managers are directly, and handsomely, incentivized to do just that. Investment banks, by contrast, are collections of disparate businesses. Most have trading units but also have to please fee-paying clients, whose wishes can lead them to do things they feel uneasy about. It's arguably no accident that Goldman Sachs Group, the investment bank in the best position to pick and choose its business partners, is the one that has come out of last year's turmoil looking cleverest. --Hedge funds are also smaller and simpler than investment banks. Even at the biggest funds, bosses typically keep a close eye on trading and are able to identify and shut down losing trades in short order. Despite heavy losses last summer that led to the closure of Sowood Capital, the fund managed by Harvard endowment alum Jeff Larson, industry experts have hailed the quick action at the fund for preventing even bigger losses. --It helps that most hedge-fund chiefs have plenty of their own cash at stake. Investment bankers are often playing with faceless shareholders' money for asymmetric rewards. Bonuses based partly on individual success are almost always going to outweigh any losses on bankers' stock holdings in a firm that has a bad year. The arrival of government investment funds to inject some $50 billion of capital into Wall Street firms like Morgan Stanley and Merrill Lynch looks like yet more of other people's money for them to bet. --But this time at least, it's the supposedly highly regulated banks that face a more pressing battle to restore their credibility.