Hedge-fund billionaires are envied and hated, demonized and mocked. Their outlandish behavior hasn’t done much for their image, as Sebastian Mallaby shows in “More Money Than God,” a history of the alpha males who play the alpha game.
George Soros, for one, imagined himself a messiah. Paul Tudor Jones shouted orders down the phone like a crazed cowboy while wearing Bruce Willis’s old sneakers. Michael Steinhardt reduced subordinates to tears.
“All I want to do is kill myself,” one said.
“Can I watch?” Steinhardt retorted.
For all their excesses -- Ken Griffin’s Versailles marriage and garage full of Ferraris come to mind -- hedge funds represent a promising if partial alternative to the banking supermarkets that “either blew up or were bailed out” during the credit crisis, argues Mallaby, a fellow at the Council on Foreign Relations and former Economist magazine staffer.
Unlike Citigroup Inc., most hedge funds live or die by their own risk management and are small enough to fail, Mallaby says: Some 5,000 of them shut down between 2000 and 2009; none required a taxpayer bailout.
“To a surprising and unrecognized degree, the future of finance lies in the history of hedge funds,” he writes.
Drinking With Hemingway
And what a history it is. Mallaby takes us back to the birth of the hedge-fund era in 1949, when a Fortune magazine writer named Alfred Winslow Jones scraped together $100,000 to try his hand at investing. Jones had knocked around Europe after graduating from Harvard and wound up drinking on the front lines of the Spanish civil war with Dorothy Parker and Ernest Hemingway. Only at age 48 did he set up his “hedged fund,” improvising an investment structure still used today.
Deploying “speculative means for conservative ends,” as he put it, Jones combined leverage (borrowed money) with short selling (the sale of borrowed assets in hopes of buying them back later at a lower price). His techniques anticipated academic breakthroughs such as Harry Markowitz’s “Portfolio Selection.” By 1968, Jones had clocked a cumulative return of just under 5,000 percent.
The narrative trundles along, introducing hedge-fund legends in chapter-long profiles showing how they profited by fingering inefficiencies in the efficient market.
We meet Steinhardt, who earned fat profits by helping institutional investors trade shares in huge blocks. We also visit Commodities Corporation, an early quantitative investing boutique. Working out of an old farmhouse in Princeton, New Jersey, the PhDs set about beating markets with math, computers and superior information. They filled a blackboard with formulas and kept a three-legged German Shepherd named Cocoa.
And so it goes. Any book on the vast hedge-fund universe is bound to have omissions. Edward Thorp, the quant godfather, is relegated to a mere footnote about his firm. Still, the bright and dark sides of quant land are captured in passages on James Simons’s band of code breakers at Renaissance Technologies Corp. and John Meriwether’s ill-fated Long-Term Capital Management LP.
Three colorful billionaires dominate the book: George Soros, with his backaches, reflexivity theory and self-confessed messianic complex; value investor Julian Robertson, a guy’s guy who hired young jocks and took them on vertical hikes; and Paul Tudor Jones, who started out as an apprentice cotton trader.
“He approached trading as a game of psychology and high- speed bluff, a kind of poker that combined sly subtlety with crazed bravado,” Mallaby writes.
Dancing Through Minefields
The lives of these contrarians come together and the pace picks up as Mallaby presses on through the East Asian currency crises of the 1990s, the dot-com bubble and the subprime meltdown. The account of how Griffin’s Citadel Investment Group LLC survived the maelstrom of 2008 is particularly telling.
Like many hedge funds, Citadel “danced through the minefields” only to get whipsawed when leverage dried up and the government moved to ban short selling after the collapse of Lehman Brothers Holdings Inc., Mallaby says.
When the crush came, Chicago-based Citadel had many advantages, notably a treasury department that had lined up a mix of loans to match the maturities of the assets in its portfolio. Unlike investment banks, Citadel aimed to use overnight funding only for assets that could be sold overnight.
The firm did get hammered, its two flagship funds plunging 55 percent in 2008. Yet Citadel’s humiliation “showed that leveraged trading firms with billions under management do not necessarily need government rescues when markets go berserk,” he says.
Mallaby says hedge-fund history suggests a two-word policy prescription: “Don’t regulate.” Yet he recommends that the funds should be subjected to a three-tiered oversight regime based on the level of their leverage and whether they remain private partnerships.
If they go public, watch out.
“More Money Than God: Hedge Funds and the Making of a New Elite” is from Penguin Press in the U.S. and from Bloomsbury in the U.K. (482 pages, $29.95, 25 pounds). To buy this book in North America, click here.
(James Pressley writes for Muse, the arts and leisure section of Bloomberg News. The opinions expressed are his own.)
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