Hedge funds are large funds, usually in the billions, belonging to wealthy individuals or institutions (e.g. pension funds). Hedge funds can be invested in a wider range of activities than most investment funds. Hedge funds are distinct from normal investment banking rules, owing to American legislation following the Great Crash in the 1930s. The legislation prohibited investment banks from engaging in a number of types of investment, including leverage and short selling. However it did not outlaw these practices. Fund managers, who dealt only with ‘accredited investors’, people with net assets of at least $1 million and an annual income of $200,000 or more, and who did not advertise their services, were allowed to continue to use these forms of investment, and these fund managers have come to be known as hedge fund managers.
It has been the subject of much comment that fund managers are able to engage in the practice of short selling, which involves borrowing shares for a fee, selling the shares on and then buying them back later at a lower price, before returning them to the share owner. The idea is that if one can predict a drop in the price of a company’s share, then short-selling will allow the trader to make a profit which more than covers the fee paid to borrow the shares. This practice has been criticised because it creates an incentive to spread rumours, which are intended to drive down the share price. I suppose too, that if word gets out that an established hedge fund has borrowed and sold shares in a certain company, faith in the hedge fund’s ability to predict a drop in the market value, may become a self-fulfilling prophesy regardless of whether the real value of the company deserves to be downgraded.
Interestingly, Donald Mackenzie, in the London Review of Books said, “An address in Mayfair counts in the world of hedge funds. It shows you’re serious, and have the money and confidence to pay the world’s most expensive commercial rents. A nondescript office no larger than a small flat can cost £150,000 a year. Something bigger and in the style that hedge funds like (glass walls, contemporary furniture) can set you back a lot more. It’s fortunate therefore that hedge funds don’t need a lot of space. Two rooms may be enough: one for meetings, for example with potential investors; one for trading and doing the associated bookkeeping. Some funds consist of only four or five people. Even a fairly large fund can operate with twenty or fewer.” Interestingly, Mackenzie also pointed out that hedge funds’ physical and legal locations are often separate. The funds themselves are normally registered offshore for tax reasons, many of them in the Cayman Islands. In the offices in Mayfair or Greenwich are the funds’ managers, the legally distinct firms or partnerships that control them.”
Hedge fund firms in London include GLG, EIM and Cheyne Capital.
Irrespective of the intricacies of hedge fund management, the startling thing is just how much hedge fund managers charge and earn. They tend to charge both a management fee and a performance fee. Management fees vary from 1 to 4% per annum, with 2% being standard; which is a hell of a lot of money. If a hedge fund manager is getting a management fee, 2% of the fund, which might say be 1 billion then they will be pocketing 20 million quid, just for managing the fund..
No surprise hedge fund managers have a wealth, which allows them to live the life of Riley. Some are ostentatious. The Daily Mail, in 2006, reported on how hedge fund managers had paid £1.5 million for a Chelsea townhouse in cash, bought a Bentley for £200,000, spent £300,000 on a diamond ring for their wife’s birthday. One manifestation of the ‘cult of cash’ is a new publication from Conde Nast, publishers of Vogue, called Trader. Aimed at the plutocrats of the new capitalism, it is filled with reviews of private jets, yachts, flash cars, advice on which Cognac to buy, and tales of excess among financiers during nights out.