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Hedge funds: The new global super powers

   

By Robert Peston Share |

Published: 12:01AM GMT 27 Jan 2008

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In our second extract from his provocative new book, Who Runs Britain? l Up to 4.40% AER fixed EXECUTIVE JOBS
Robert Peston asks whether the new Masters of the Universe should be rate with HiSAVE. Find
using their talents to save the world rather than making themselves out more
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Your view: Who runs Britain?
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Part one: Pointing fingers at the plutocrats international transfer
rates
To find where true power and super-riches lie in modern Britain, go to the
thickets of the hedge funds. In January 2007, $261bn of hedge fund money was
managed from London by 72 firms that each control more than $1bn. That
makes London the second largest hedge fund centre after New York.

  Although they are usually described as City

Related Articles businesses, most of them are not based in the
Pointing fingers at the Square Mile, London's financial district, or in the
plutocrats towers of Canary Wharf. Their stupendously rewarded
Is it time to go back managers live and work in Mayfair, Knightsbridge,
into property? Belgravia, Covent Garden and Chelsea. The journey
Super rich detached from overpriced home to overpriced office to
from property slump, overpriced restaurant is just a short walk.
says Knight Frank
Wall Street crisis: this
Habitually tieless and dressed-down casual, they sit
should be Barack
Obama's moment
at computer screens and construct complicated
trading strategies. Many of them stay at their desks
without pause or interruption from 7am to 9pm on
weekdays and maintain electronic contact with markets at all other times. They
are not to be pitied. Some of them are worth hundreds of millions of pounds.

One of the most successful of the younger generation of hedge fund tycoons is
Nathaniel "Nat" Rothschild, the son of Lord (Jacob) Rothschild. He is a founder
and co-chairman of Atticus Capital, which has $8bn under management.
Atticus made a fortune from identifying early that Europe's stock exchanges
were ripe to be taken over and merged with each other. According to Alpha
magazine, he earned $240m from Atticus in 2006.

Two other members of the City's new elite are Ian Wace and Paul Marshall,
who in 1997 set up a hedge fund, Marshall Wace, that is now one of the 10
largest in Europe. It has magnificent open-plan offices on the top floor of the
Adelphi building off the Strand in London, with a glorious view of the Thames.

It sifts 800 trading tips a day, or well over 200,000 a year, from more than 1,400
brokers to whom it reputedly pays commissions worth $250m a year. When it
opened a new fund focused on North American equities in 2005, it raised $1bn
in a single day.

On the back of all this frantic activity, Marshall and Wace have become
immensely wealthy. In the two years to August 2004 their combined pay and
dividends totalled almost £50m.

Globally, there were 10 hedge fund managers who in 2006 earned more than
$500m each - not $500m per firm but per individual. And five earned more than
$900m. Steve Cohen pocketed an estimated $900m, George Soros $950m,
Edward Lampert $1.3bn, Kenneth Griffin $1.4bn and the extraordinary James
Simons $1.7bn.

The highest-paid British-based hedge fund tycoons in 2006 were Noam

Gottesman and Pierre Lagrange of GLG, earning a reputed $240m. A London-
based hedge fund partner can expect to earn $40m a year and even a half-
decent trader can earn a seven-figure salary.

This is wealth beyond the dreams of avarice and it has brought about a
dramatic power shift in the City. The profits and influence that used to belong to
famous City bankers such as Warburg and Cazenove are now in the hands of
hundreds of clever individuals, the hedge fund superstars, who are making more
money than they could spend in a lifetime.

But for all their cleverness and macho confidence, they shun publicity as if it
were pure Kryptonite. In 2003, the world's most successful hedge fund
manager, Eddie Lampert, was kidnapped and held to ransom for two days.
Famously, he talked his way out, but the experience has made others secretive
and almost irrationally hostile to the outside world.

"If you publish things like that [financial information]," one hedge fund manager
told me, "my children's lives get endangered. They put a gun to Eddie Lampert's
head and he was lucky to get away with his life."

One consequence of the hedge fund (and private equity) boom is that the riches
they offer act as an irresistible magnet to the brightest and best. This is not to
argue that what they do is intrinsically heinous: every time they make a profit or
a deal, they should be correcting a market failure, or improving its efficiency by
helping to ensure that capital is allocated to the right projects and places at the
right price.

But if someone has a facility for complex analysis, wouldn't the world be a
better place if they deployed their talents on solving climate change or using the
new science of genomics to find cures for fatal illnesses?

"I am an engineer by training," one hedge fund manager told me. "I moved out of
engineering into the City in the mid-1990s. I couldn't believe people would want
to pay you that much money for creating nothing.

"I can argue that we are doing a good thing for the global economy by making
financial markets efficient and channelling money to the most efficient users.
We are not leeches on society. But the idea of having all the creative people in
the financial markets is rather the tail wagging the dog. Having said that, it's
very good fun."

You have to go to America, to the headquarters of Renaissance Technologies,

to see the extreme version of the brain drain into hedge funds. Renaissance,
with offices in Manhattan and East Setauket, New York, is like something out
of science fiction. It employs about 80 PhDs - with skills from astrophysics to
linguistics - all of whom help Renaissance's founder, James Simons, construct
computer programs or algorithms that can identify profitable opportunities in
financial markets.

Simons is a 70-year-old prize-winning mathematician and former code-breaking

cryptologist. His success has been prodigious. Renaissance has about $25bn
under management in two funds - and is aiming for $105bn. His personal
rewards almost defy comprehension. In 2006 he pocketed $1.7bn, making him
the best-paid hedge fund manager in the world.

Simons is not a flashy individual and devotes some of his time and money to
raising standards of maths education in American state schools. But would the
US be better or worse off if the formidable brainpower at Renaissance were not
applied solely to the remorseless pursuit of trading profits?

What hedge funds tend to have in common is a dedication to an extreme form

of capitalism - but not a lot else. Much of what they do has been the stuff of
swashbuckling banking for centuries. The electronic element of the business is
new, but the pursuit of dealing profits is as old as civilisation.

They engage in a bewildering range of activities. Some buy and sell whole
companies, just like private equity. Or they deal in commodities, or individual
shares, or bonds, or currencies, or the debt of troubled companies, or complex
financial products such as credit default swaps and collateralised debt
obligations. They are responsible for transactions worth trillions of dollars every
year.

They endeavour to measure the intrinsic riskiness of holding a particular asset

and see if that risk has been captured in the market price of the asset. If the
price is too low, relative to the risk, they will buy the asset. If it is too high, they
will sell.

Today, hedge funds are supporting the vast global infrastructure of the largest
investment banks. As a leading prime broker at a US bank put it: "If you are a
retail store, you love the family with 12 kids. Hedge funds have 12 kids for us."
So this "family" is in a strong position to boss around a Morgan Stanley or a
Goldman Sachs.

United by a ferocious determination to make money and to "win", the hedge

funds have blurred the concept of nationality. What is the nationality of a typical
British-based hedge fund, run by a mixture of English, French and American
managers, which operates in Mayfair but is domiciled for tax and legal purposes
in the Cayman Islands?

Keen that Britain's financial services should flourish, to engender the economic
activity that provides tax revenue, Gordon Brown as Chancellor turned a blind
eye to how those on the very highest earnings in the City often pay relatively
little tax. He showed that he was happy for them to work in London while basing
themselves for tax purposes in overseas tax havens.

But as someone who values the City's creativity, he could have done a great
deal more to spread the wealth around. The success of hedge funds is
frequently a giant profit forgone by the rest of us, or - more properly - lost by the
pension funds responsible for the retirement income of millions of people.

British pension funds tend to be modest backers of hedge funds: most of the
money behind UK-managed hedge funds comes from abroad and from wealthy
individuals. Pensions funds' historic wariness of hedge funds is one reason why,
if you are in an occupational pension scheme, the annual contributions made
by you and your employer have been rising - but are earning diminishing
returns. Those higher returns have been available but they have not been seized
by your pension fund on your behalf.

For all the arguments that will rage and rage about whether hedge funds are a
global toxin or the efficient distributors of capital to the most deserving
businesses and markets, there is an honest simplicity in their greed that
shames the conventional fund managers who look after most of our retirement
savings. Who Runs Britain? by Robert Peston (Hodder & Stoughton, £20) is
available for £16 + £1.25 p&p. To order, please call Telegraph Books on 0870
428 4112 or go to www.books.telegraph.co.uk

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