New York Magazine Focuses On Hedge Funds

by: Christopher Holt

The glossy pages of the venerable New York Magazine isn’t the first place you’d expect to find a comprehensive survey of the hedge fund industry. Beating out a story about a serial murder selling his kidney ("Tainted Kidney”), a revealing piece on exhibitionism in the Big Apple, and the ramblings of a Mister “James J. Cramer”, an interesting set of articles on the New York hedge fund scene takes pole position as this week’s cover story.

The lead article, “Running of the Hedgehogs”, is an introduction to the industry that spares us from some of the usual fear mongering and populist drivel the mainstream media often dishes out on the subject. In fact, the magazine addresses this phenomenon head-on:

The New York Times decided years ago to incessantly refer to hedge funds’ use of these instruments as ‘exotic and risky,’ thereby adding to their aura of mystery. The funny thing: Practically all financial institutions use these “exotic” instruments.

The article also goes on to challenge other popular misconceptions such as the belief that hedge funds are all the same.

A persistent misconception in the general public is that all hedge funds act alike. Not true. On the one hand, you have the nerd brigade, with their fine-tuned software-driven investment strategies that are constantly refined by ‘rocket scientists….At the opposite extreme, you have the table-pounding, executive-belittling activists…

The myth-busting continues with this observation about the actual income of a typical hedge fund manager:

Three out of ten of us think the average hedge-fund pro makes more than $10 million a year. He doesn’t.

Hedge funds sometimes get confused with private equity, the financial specialty that’s gotten the most ink these past few months.

Believe it or not, it’s harder to start a hedge fund now than it was a few years ago. According to Hedge Fund Research, in 2006, 1,518 hedge funds launched, compared with 2,073 in 2005. Robert Merton, a Nobel Prize–winning economist, couldn’t raise enough to launch a fund last year and abandoned his effort.

But despite his admirable attempts to set the record straight on hedge funds, the article’s author, Duff Macdonald, apparently couldn’t resist using some colorful analogies - like this humdinger about a dinner attended by several large hedge funds:

It’s chilling to think of all that secret power assembled in one place, like the Cosa Nostra Apalachin summit in 1957. Attendees included Jim Chanos of Kynikos Capital, Rich Chilton of Chilton Investment Co., Stevie Cohen, Stanley Druckenmiller, Paul Tudor Jones II of Tudor Capital, and David Tepper of Appaloosa Management. The combined assets under management of those attending had to have been $200 billion.

Please, that’s a stretch. For starters, the Cosa Nostra Apalachin summit took place over the whole weekend, not just one dinner(!). Plus, the Cosa Nostra summit took place in Apalachin, not New York…

In any case, the article ends on the same balanced note on which it started:I scream, you scream, we all scream...because that's a freaking hedgehog in a cone!

So, in the end, when someone blurts out, “Hedge funds are a venal get-rich scheme that we’ll all end up paying for,” should you nod solemnly like you agree? No, don’t do that. Try instead to crib the argument of an actual hedge-fund manager: “The proliferation of hedge funds has both decreased volatility in the market and increased the long-term risk of a systematic collapse. In the first case, it’s because hedge funds are more nimble than traditional long-only funds and can swoop in and correct market mispricings before they can get extreme. But it also means opportunities become fewer. And because hedge funds need good returns through the cycle, this reduced opportunity forces them to take more and more risk, increasing their exposure to risky investments, which, in the long term, will increase the likelihood of a systematic panic in the market.

Did everyone get that? (Simply hit “print” for your own easy-to-access response to tired and old “venal get-rich scheme” malarkey.)

The magazine also contains an interesting “Who’s Who” of the NY hedge fund industry, along with an attempt to explain the paradox of consistently high hedge fund fees, “Why Aren’t Hedge Fund Fees Dropping?” (hint: “Heart surgeons don’t tend to compete on price either”), and why 40% of the world’s largest funds are located in “Upper-” and “Lower- Hedgistan” (a.k.a. Greenwich & The Upper East Side/Plaza District).