As heard on TV one morning while shaving:
Morning Show Talking Head: So tell us what drives hedge fund managers?
Hedge Fund Dude: It’s just never ending. Thinking about
what is going to work next. I have a friend who is worth $150 million
who is working some new ideas for a fund.
Talking Head: If I had $150 million, the last thing I would do is start a hedge fund.
Hedge Fund Dude: That’s why you don’t have $150 million.
What exactly is a hedge fund? It’s nothing more than an investment vehicle that can buy and sell almost anything. Unlike mutual funds that just charge 1 to 2 percent of assets as a fee no matter how they do, hedge funds get to keep 20 percent (and often more) of their investment gains. It’s an incentive for their managers to lead bizarre lives and suffer from mental anguish. You think they should go crazy for free?
According to Hedge Fund Research, $1.568 trillion dollars is now managed by hedge funds. This isn’t small potatoes. Who are these masked men and women? And how is it they make so much money, some of them hundreds of millions of dollars a year, for themselves?
While capital sloshes around the globe seeking its highest returns, most money is slow, almost sedentary, kind of meandering around like a humpback whale looking for easy pickings. Hedge funds, on the other hand, are playing a game of Whac-a-Mole. Whenever anything with a potential return pops up its head, young cobras staring at multicolored screens blast the mole into submission, quickly buying underpriced shares or dumping overpriced ones. How do they know what is over- or underpriced? That’s their dirty little secret. There is no one answer.
My partner and I started and ran what ended up being a $1 billion fund investing in small emerging technology companies out of a dumpy office over an arts store in Palo Alto. We started in 1996 with not much capital, did well, and by the middle of 1999, had several groups from the Middle East try to force another billion dollars on us. Heady times. Despite being called crazy, we not only turned them down, but ended up sending our existing investors their money back over the next 18 months. When the bubble burst, it was a lesson learned that when someone begs you to take their money, you probably don’t want it!
I’ve also met my share of hedgies. The common thread that runs through us all is a personality disorder. The only way I can describe it is sort of an inner George Costanza – working hard to stay shallow. Here are a few guiding principles:
• Don’t believe in anything.
• Let the world happen and then pass judgment.
• Bias leads to disaster.
• Be emptyheaded and fleet of foot.
• Change your mind often.
• Observe and critique, 24/7.
(Stevie Cohen of $12 billion SAC Capital Advisors even looks like George Costanza.)
Hedgies’ M.O.’s are almost always the same: figure out what everyone else knows and why they are wrong. If the market is wrong — and it is all the time for lots of reasons, including indexing, foreign buying and emotion — then securities will be mispriced, which means there are great returns to be made.
What do I mean? I’ve already written about morals getting in the way of good investments. Well, so does everything else. You don’t see hedgies write opinion pieces because they don’t have opinions. Others do, and they are often wrong.
Hedgies come to work (early) as blank slates. “What does everyone out there think today? Hmm. Oil up $2 because of rigged Nigerian elections and Venezuelan nationalizations. Others think it will spill over, but they’re being too emotional. No way it’s worth $2, I’ll take the other side of that trade.”
When running money, you can’t get away from this shallowness. At cocktail parties and at Little League games, you’re trying to find the other side of the trade. It’s no way to go through life. Really.
The key word is “blank.” The trick is to stay as unemotional as possible yet recognize everyone else’s emotions as flaws. A hurricane hits, people are stranded on roofs and the market sells off 200 points, taking everything down. But you start buying lumber companies and Berkshire Hathaway, because plywood prices are going up, and it’s almost guaranteed that Warren Buffet is going to raise insurance premiums – he always does.
Sometimes it’s stocks, sometimes bonds, or oil, or currency. Whatever isn’t nailed down can be traded. In fact, the best hedgies never buy things, they just wait until someone insists on selling to them at the wrong price.
Two years ago, Michael Jackson had a little cash flow problem in the midst of his child-molestation trial. Bank of America was calling in two loans totaling $270 million. Hedge fund Fortress Investment Group came to the rescue as good Samaritans (hardly, one can just hear Michael Jackson begging), buying the loans out. Of course this was in exchange for some collateral — Jackson’s copyrights of 200 Beatles songs, which some folks estimate is worth $400 million, plus Jackson’s own music copyrights (a rather dwindling asset) and a partial deed on Neverland Ranch, unfed giraffes, elephants and all. The loan was paid back – with huge returns for Fortress.
Eddie Lampert of $18 billion ESL Investments, while watching K-Mart self-destruct five years ago, sniffed out a mispriced real estate play. He figured that the land under the stores was worth more than the retailer was trading for. So he bought and bought their stock when no one else wanted it and ended up controlling K-Mart. In a violation of that fleet of foot thing, he merged the company with Sears to keep the stock up. Oops, maybe he got emotional (or had a thing for Jacklyn Smith!)
Most of the hedge fund money is with the handful of players that are really good at it, those that can stay emptyheaded and whack moles quicker than the rest. Seventy percent of all hedge fund money is managed by the 100 top funds. Even so, new hedge funds start up all the time. It goes on and on. Of course, as more George Costanzas wielding hammers in bigger and bigger funds chase a diminishing number of moles to whack, it gets tougher to stay shallow, tougher to make a buck. But until then, it’s the Summer of George.
http://kessler.blogs.nytimes.com/2007/04/23/blank-slate-hedgies/
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Posted by: medicines from europe | November 09, 2008 at 12:54 PM