Wall Street-on-Sea feels the chill amid talk of shake-out

Date: Tuesday, August 28, 2007
Author: Andrew Clark, The Guardian

Only the fittest investment houses will remain when market volatility subsides.

Sandwiched between fine art galleries, cigar stores and designer fashion boutiques, the Subway barber shop on Greenwich Avenue clips short, smart "business cuts" for a clientele of hedge fund managers. Business has been slow lately and the clients seem slightly tetchy.

"Overall, we haven't had so many of them coming in as usual," says hairdresser Antonio Merolla, who adds that the moneyed financiers are good tippers during better times. "The few that I've spoken to have shown concern and are a little, shall we say, uptight."

The affluent waterside enclave of Greenwich is 30 miles east of New York and has been America's hedge fund capital since the September 11 attacks made Manhattan less appealing. Nicknamed "Wall Street-on-Sea" or "Upper Hedgistan", the town is home to more than 380 firms managing $100bn. Battered by this summer's market volatility, the usual mood of easy confidence has acquired a certain chilly edge.

Over a spectacular decade, hedge funds have spawned staggering wealth. Greenwich is dotted with sprawling mansions: a $14.8m estate owned by SAC Capital's Stevie Cohen stretches over 32,000 square feet, boasts an ice rink and was likened by Vanity Fair magazine to Windsor Castle. Some managers commute from their waterfront estates by power boat to a pier at the end of the town's main street.

Conceived as a way for the super-rich to play the markets on a riskier level, hedge funds have entered the mainstream. Their seemingly impossible returns have attracted pension money, insurance firms and savings funds as clients. According to Chicago-based Hedge Fund Research, the industry comprises 9,767 firms worldwide looking after an eye-watering $1.74 trillion.

Red numbers

But the collapse in America's credit market prompted by defaults on sub-prime mortgages has been a shock. Hedge funds are among the biggest losers from the summer of red numbers. Some, including Boston-based Sowood Capital and Australia's Basis Capital, have lost as much as 80% of their value. Wall Street titans such as Bear Stearns and Goldman Sachs have pumped billions into their own funds to keep them afloat.

Critics are wondering, not without relish, whether the industry is ripe for a major shake-out. Some suggest that hedge funds are fine for specialist investors - but that they have oversold themselves and understated risks to an increasingly wide population of punters.

Peter Morici, professor of finance at the State University of New York, says the hedge fund space is too crowded: "It seems obvious that if large numbers of people saying they have models that can beat the market, it becomes impossible to beat the market."

He accepts that hedge funds provide valuable arbitrage in global markets by spotting and pouncing on price discrepancies. But, he says: "I do believe the people who manage hedge funds have probably oversold them to investors. Investors believe they are less risky than they actually are."

An American lawyer, Jake Zamansky, is preparing a case against Bear Stearns claiming it misrepresented its funds to clients including British investors who lost more than $50m. The industry is on the back foot - so is reform in the air?

Roger Ibbotson is chairman of Zebra Capital Management, a $270m Connecticut hedge fund using the type of computer-driven technique which has struggled to cope with August's volatility. He concedes: "There have been some surprising drops among some funds you might never have guessed would have had blow-ups."

However, he says many "quantitative" funds have already bounced back - at the end of last week, Zebra was down about 2% for the month but still up for the year.

"There have always been scandals and blow-ups from time to time," he says. "Usually there's some slowdown after each of them but the blow-ups leave opportunities for the remaining funds."

David Friedland, president of a "fund of funds" called Magnum US Investments, takes a similar view. "It hasn't been a good month by any stretch of the imagination," he says. "A shake-out is good every now and again - it separates the men from the boys."

The public image of hedge fund managers is poor. They are often viewed as brash, Ferrari-driving plunderers of short-term value. Just recently, it emerged that one manager, Bertrand des Pallieres, failed to notice for three months that his £80,000 Maserati had been impounded for his failure to pay London's congestion charge.

Ari Kiev, a psychologist whose book Hedge Fund Masters examines the industry's outlook, says most are motivated by status, rather than pure cash: "It may be numbers on a screen, but it translates into planes, helicopters, second homes, third homes, the ability to buy companies and raise the game to the next level.

"It's not for the money - it's for the game. And the score is the money."

Voices of concern at this "game" are gaining force. Corporate leaders, including the CBI's former president Sir John Sunderland, dislike seeing hedge funds creep up shareholder registers, complaining that their swift trading culture neglects long-term value for short-term rewards. Unions argue that given their power, funds should pay more attention to the ethics and governance of the firms they invest in.

"It's important that there should be transparency and accountability - which we're just not seeing at the moment," says Dan Pedrotty, director of investment for America's AFL-CIO union movement. He says an unlikely coalition is forming: "You're actually seeing an alliance between companies concerned about these same problems as unions and individual investors."

Darwinian

Andrew Baker, deputy chief executive of Britain's Alternative Investment Management Association, protests that a few over-ambitious funds have damaged perceptions.

"It's a gross simplification to tar the industry with the same brush," he says. "There are some funds out there with short horizons and high turnover. There are others with low turnover who want to engage with management in constructive argument."

Those who have over-leveraged themselves on excessive debt, he adds, will go under through "good Darwinian captalism".

Back in Greenwich, the restaurants are buzzing a little less than usual - and a Rolls-Royce showroom opposite the railway station seems devoid of customers. At the Quai Voltaire antiques shop, manager Cyril Flichy says: "People are paying attention to what they spend a little bit more."

Still, he reckons a careful bit of marketing usually pays off. Gesturing towards a $9,900 delicately painted Louis XIV wooden table, he says: "It's important to present things not as an expense but an investment.

"This table is in perfect condition and it's been around since the 17th century. Its value is never going to fall by very much."