The Independent - London
News Analysis: Hedge funds' problems could push markets over the brink Macro investors are finding it increasingly difficult to make their mark in the international markets
By Andrew Garfield, Financial Editor
HEDGE FUNDS, the notorious troublemakers of the world of finance, are again in the news. Last week concern about the financial robustness of Julian Robertson's Tiger Fund was spooking the market. This week the attention has shifted to George Soros' flagship Quantum fund which on Tuesday announced a top management reshuffle bringing in Duncan Hennes, a former Bankers Trust executive, in an attempt to reverse nearly three years of relative decline.
Although George Soros, who is still remembered on these shores as the man who broke the Bank of England and with it, John Major's government, inevitably grabs the headlines, many believe Tiger's problems potentially matter more.
Mr Robertson's $12bn fund is a big equity investor. Its UK holdings include a 4.2 per cent stake in Next, the clothes retailer and a 6.05 per cent stake in the Royal Bank of Scotland. Last week, just days after offloading a 3.9 per cent holding in Societe Generale, the French bank to Britain's CGU, Tiger confirmed that its 22.4 per cent stake in US Airways, its biggest single holding, was also up for sale.
A fire sale of these holdings could play havoc, not just with these individual companies but with sentiment right across the board.
Tiger, like most hedge funds keeps its cards close to its chest. But privately those close to the fund admit that this has not been a good year.
The fund is down 7 per cent in the year to June on top of a 4 per cent fall last year. This year, the cause, industry insiders say, has been a decision to go short of the Japanese equity market just when the Nikkei has spluttered back to life. How short, no-one knows.
Soros in trouble makes good headlines. But the reality is not so simple.Quantum, his $6.7bn fund, is down and has been year after year for the past three years. Units in the fund have sold at a discount since late last year.
But Quota, the smaller $1.9bn Soros fund which is run by the reclusive Nick Roditi from Hampstead has bounced back spectacularly well. It is up 14.5 per cent this year, after a 46 per cent drop in 1998. Mr Roditi quit for a while last year because of illness, but he is back and clearly in good form. Mr Roditi apparently took the contrary bet to Robertson - that Japanese stocks would rise.
Nevertheless, Quantum is the fund mostly closely associated with Mr Soros. For some years now it has been managed by Stanley Druckenmiller.
Quantum's big mistake this year, it is said, is to have speculated that the European Central Bank would pull out all the stops to ensure the euro was a strong currency from birth. As everyone now knows, the euro has steadily lost ground against the dollar this year.
Last year the story was that the Soros' funds were hit like Robertson's by the collapse of the yen carry trade - borrowing cheaply in yen to buy higher-yielding dollar-denominated securities - great business as long as you know which way the yen is going to move.
Such losses look bad but they are not going to bring down the world's financial system. Yet underperforming the benchmark US stock index, Standard & Poors, particularly in an industry which sneers at the lack of ambition of conventional fund managers who are happy to more or less track stock market indices, is still bad news. Underperformance means disgruntled investors rushing for the door, and since hedge fund managers are paid a big slice of profits - typically 20 per cent - when you make losses your top people quit. That triggers further underperformance, more investor defections and a vicious cycle sets in.
Mr Robertson lost his number two, Andreas Halvorson, earlier this year. Since then, say insiders, the haemorrhage of talent has continued despite Mr Robertson's attempts to keep his best staff by paying them out of his own pocket.
In one respect, hedge fund managers are no different from any other asset manager. When things go well, it is ascribed to their own brilliance; when things go wrong, it is the market's fault for moving against them. This time blaming the market will not wash. Not only have conventional fund managers performed well because of the strong showing of most stock markets this year over all, but other hedge fund managers have chalked up sterling performances. According to Van Hedge Fund Advisors, the industry bible, US hedge funds as a group easily beat the S&P 500 with a 15.1 per cent net return in the year to July against 8.9 per cent for S&P.
Nor is it just a question of investment style. Mr Robertson and Mr Soros are both what the hedge fund calls "macro" operators, taking big one-way bets on markets. Both make much of their geo-political analysis, as well as more straightforward stock picking skills.
Yet other, less well-known, macro operators like Louis Bacon and Bruce Kovner have had a good year - in Mr Bacon's case spectacularly so. His fund is up 22 per cent.
Rumours persist Tiger's problems are worse than it is letting on. Investor chat rooms in the US talk wildly and without a shred of evidence about covert G7 central bank hedge fund bail-outs. Macro hedge funds are notorious for taking big one-way bets, and the bigger they get, the harder it is for them to deliver the returns that their rich investors expect without taking bigger, even dangerous punts. "The trouble is that some funds have gotten too big and eventually whatever they say they have no choice but to take bets in the currency and bond markets," one hedge fund manager said.
There is no doubt that regulators are quietly stepping up surveillance.
Are we looking again at the kind of global meltdown scenarios that forced Bill McDonough, the head of the New York Federal Reserve, to summon the heads of the big global banks last September and order them to bail out John Meriwether's Long-Term Capital Management? The recent steep rise in spreads in the swaps marketcould be a sign of impending disaster. The sharp rise in long-term bond yields is also way out of line with the fundamentals.
But analysts say there is no-one out there as leveraged as LTCM in its heyday when its total positions in the various bond and derivatives market stood at several hundred per cent of its $3.5bn capital base. The fear is not so much that there is a disaster we don't know about but that the wholesale derivative markets are in such a febrile state that an unforeseen crisis now could push them over the brink.
Caption: George Soros' Quantum fund speculated the European Central Bank would pull out all stops for the euro
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