Not Born Yesterday/ Investigation

Time to unfold the Hedgehogs

When something sounds ethereal, is difficult to explain, and based on greed, the chances are it’s not a good idea. This applies to most walks of life, but especially to the world of ‘high’ finance: as a description, it also fits Hedge Funds perfectly – whether you’re an ordinary citizen, a corporation, or the Government.

Saying ‘Hedge funds’ carelessly is a bit like saying ‘black people’: the variety is so enormous as to make the term almost meaningless. But despite widely differing modus operandi, they are a single sector united by one overall concept: making hay come rain or come shine. When such an idea is behind $2 trillion of investment, accounts for 50% of all trades on the London Stock Exchange, is growing like topsy and highly secretive, it deserves to be looked at closely and judged on its merits.

My approach to investment in anything has always been based on two simple principles – it must meet all my common-sense criteria, and it must be for the general good. Over time I’ve discovered that, on the whole, they tend to go together. So on those bases, here are eight straightforward reasons why Hedge funds are a pernicious influence:

  1. Their objective cannot be met without doing harm. In the broadest sense, what I mean by this is that Hedge funds aim to make money when times are good and bad. If you’re an honest person with a proper job in one business, that can’t be done.
  2. They manipulate sectors using the spurious ‘technical value’ definition of what is ‘a fair price for a stock’. Allegedly, these days it’s largely Hedge computers deciding on a ‘fair’ price, but the game is not hard to follow: two stocks in one sector, one more expensive than the other – so sell the ‘overpriced’ one and buy the ‘good value’ one massively. (‘Massively’ means using the leverage of the fund). Once the cheap price rises, sell it. Too bad if the higher-priced stock is in a good company and the cheap one in a bad….but not for the Hedge fund: it then buys the cheaper (formerly expensive) fund and watches its value climb back to the real ‘normal’, then sells that one too.
  3. Leverage is a finance euphemism meaning ‘muscle’. It’s nearly always based on money the Fund operators don’t have. In other words, ‘might is right even when you’re not mighty’. Think of Hitler marching into the Rhineland with cardboard tanks, and you’re about there.
  4. In many cases, it’s also making money from decline. Lest you’re in any doubt, this is the wrong way round. The temptation is then to cause decline by manipulation – which, if you control half of all trades, is pretty easy to do. You can then reduce a company’s value to make a takeover cheaper: and the involvement of Hedge funds in this area is murky to say the least.
  5. The whole ethos of Hedge funds is socially selfish. First, only very rich and sophisticated investors are allowed in: so why is half the stock market based purely on making the very rich even richer? This too was not the original (and best) idea of a Bourse. Second, they take positions on things without regard to the harm it might do to ordinary citizens. In 1992, Hedge funds drove Sterling out of the ERM and cost the UK £12 billion of taxpayers’ money. Finally, the vast majority of Hedge fund profits are offshore, so as non-doms they attract no tax. Or put another way, they dick around with taxpayers’ money, but don’t contribute to the pot.
  6. They’re very secretive – which is understandable if you have a unique strategy, but the reality is that ultimately great minds rarely differ. The danger is ever-present of several funds having the same idea at the same time – with market-skewing knock-on effects that can be disastrous. The existence of a conspiracy or not is irrelevant: mega-damage is still mega-damage, whether by accident or design.
  7. These days the funds apply their myriad methods to everything from equities to commodities. Driving the price of food up is not nice, especially for those who can’t afford it. Driving the price of oil up is good in the long-term because it helps move us away from planet-destroying fuels: but let’s not confuse motive with profit. Let’s just say ‘profit motive’ and be realistic about it.
  8. Hedge funds are almost completely unregulated. We all know enough about deregulation to take a jaundiced view of it: but these guys have never been regulated. That sort of thing tends to happen when you have tons of money and lots of powerful friends. Suffice to say that leaving 50% of all stock market trades unregulated means one might as well not bother.

When times are tough and volatile, it would be nice to have that kind of money inside the tent rather than…well, you know the alternative. Of course, there are always apologists for everything from arms dealers via Swiss banks to pharmcos. But anyone with ethics (just the one ethic would be good) smiles and says “Yeh, right”.

The most common defence is that Hedge funds reduce volatility. The answer is they could - but as often as not they don’t, because that’s not what they’re about. The other argument (that they increase liquidity) wasn’t what you might call ‘evident’ during the recent transaction-poverty between banks.

So the bottom line is that it would be a good idea to have them strictly regulated and their market share capped: hard to do effectively…..but on just about any basis, an urgent necessity.

If you find this harsh, let me summarise. In return for contributing very little to human happiness, Hedge funds attack currencies, screw up government strategies, bully achiever companies, create crises, pay nothing in tax, bankrupt entrepreneurs, rob exchequers, have only their own interests at heart, profit from misfortune….and answer to nobody.

But there’s a bigger reason than all that for getting them under tight control, and it comes back to my common-sense criterion. Read this Wharton College definition of leverage in the Hedge fund context:

‘Leverage (or gearing) is using given resources in such a way that the potential positive or negative outcome is magnified and/or enhanced. It generally refers to using borrowed funds, or debt’

Magnifying and enhancing things is, by definition, falsifying reality - it is manipulating to speculate, pure and simple. And using debt to do so will never be a good idea, because using other people’s money places less value on it, thus encouraging foolhardiness. All free marketeers rightly claim this about government expenditure: they should accept the principle wherever it occurs.

Ultimately, ‘Hedge’ is the wrong name for such funds. They’re really used by and for people who want to win on the swings and the roundabouts - which breaks every rule of common sense fairness, and thus damns them on both my investment criteria.

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Although they may be the Masons of the investment sector, Hedge funds account for half of all transactions on the London Stock Exchange, are quite happy to take on governments if necessary,and control some two trillion dollars in play.

Nby looks at whether they're a force for good, or apocalyptic horsemen