Thursday, 11 March 2010

Hug a hedgie

There's a good piece by Hugh Hendry in the Torygraph in defence of hedge funds. I don't agree with a number of the arguments. For example:
In short selling, investors borrow shares and sell them, hoping that the price will fall and they can buy the shares later at a lower price, replace them and thereby turn a profit.

Hedge funds are not seeking to dictate economic affairs. Rather we are preoccupied by price. A market-based economy like ours requires a pricing mechanism to allocate resources and ensure that we all prosper. Get it wrong and we endure the calamity of the technology bubble and the sleazy debacle of the American mortgage crisis.

My issue here is that shorting was available as an option during both bubbles, but failed to dent them, so I dunno if it really has the market-wide benefits that are claimed (or implied in this case).

But anyway, it's a decent defence.


Andrew Curry said...

I don't have enough time to count the reasons why your post - and the Telegraph article - are way too soft on hedge funds.

But just a quick reminder that hedge funds are largely speculative financial instruments which tend to seek short-run opportunities where they find them. As the quote says, they are preoccpied by price.

That means when there's a speculative run on food prices, as there was in 2008, hedge funds will be following the surge. In parts of Africa, people died from that speculative surge.

When oil prices went up, part of that spike was down to hedge fund activity. There's strong analysis which says that the recession has been deeper and longer because of the involvement of hedge fund speculators in the oil price rush.

Since then, they've been involved in the sugar spike, the sale of Cadbury's, even (though it's trivial in comparison) the underwriting of the debt laden ownership of Manchester Utd.

I don't think that a single one of these activities would qualify as socially useful. For every 1% of benefit they offer in tiny smoothings of an excessively speculative financial system, they contribute 99% of long-term social harm. In fact, the hedge fund slogan should probably be, "pimp my financial system". They kill people and they wreck lives as a result of their direct activities. Despite what their PR would have us believe. I'm astonished that they continue to get away with it.

Tom Powdrill said...

Hi Andrew

I share some of your concerns, but I genuinely don't think hedge funds are the right target.

For a start what exactly is a hedge fund? I don't they can be described as an financial instrument, and I'm not sure it's really an asset class (though that is how hedge funds are frequently described). In essence they are just specialist fund managers, though often with a far more unconstrained mandate than the traditional long-only mob.

Seen in this way, a lot of the attacks on hedge funds are actually (sometimes quite legitimate) criticisms of market practices in general, not of hedge funds specifically. Speculative behaviour in all markets is by no means the preserve of hedge funds. For example, I agree that speculation has affected the oil price in recent history, but are you sure it was particularly hedge funds?

And all fund management is preoccupied with price, and often over a relatively short-term timeframe. As just one example, traditional long-only asset managers will probably have played a substantially bigger role in the Cadbury's takeover than hedge funds. I read somewhere that about 20% of Cadbury' stock was with hedge funds the time of the sale - but who was managing the other 80%? No doubt a mixture of asset managers, insurers, pension funds, mutual funds etc. The traditional institutions in other words are the ones that sold the company, rightly or wrongly.

I'm not trying to let hedge funds off the hook for anything. I'm in favour of ideas like restricting ownership rights for those who have held shares for a set period, for example. That's because I don't think that investors who are explicitly only concerned with the short-term need to have a say in the long-term future of a company.

So personally I think we ought to focus on what the specifics are that we don't like and seek to address them. Blaming a lot on a rather fuzzily-defined subset of investors may miss the target.