More Money Than God: Hedge Funds and the Making of the New Elite, by Sebastian Mallaby, Bloomsbury RRP£25, 496 pages
In the Soviet Union, the economy was run by the bureaucrats and their five-year plans. In capitalist economies, the job of allocating capital – picking which industries and businesses to fund, and which to let go to the wall – has been done by commercial banks, investment banks and, most recently, hedge funds. These freewheeling money managers shift cash rapidly between countries and companies, taking advantage of flaws in markets in ways that frequently produce eye-popping returns – and less frequent, but equally spectacular, implosions.
Governments across the developed world are now trying to turn back the clock. No one is suggesting five-year plans, although the Chinese dictatorship is eyed with envy by some in the recession-ravaged west. But a concerted effort to undermine hedge funds and give governments more of a say in capital decisions is under way.
Sebastian Mallaby’s contribution to this debate will not be appreciated by Angela Merkel, the German chancellor, or Nicolas Sarkozy, the French president who recently backed Merkel’s efforts to restrict short-selling, a tool wielded to deadly effect by hedge funds to make money from falling prices. In More Money Than God, Mallaby, a fellow at the US Council on Foreign Relations and a Washington Post columnist, argues that not only should hedge funds not be blamed for the world’s economic woes, they should be actively encouraged.
The book sets out a warts-and-all history of hedge funds, focusing on the great names of the industry, starting with Alfred Winslow Jones. This former communist activist and friend of Ernest Hemingway stumbled on the money-making model in 1949, and claimed inspiration from Phoenician traders to justify taking a 20 per cent cut of profits. In his wake came some of the great names who dominated investing in the later part of the 20th century and the start of the 21st: Michael Steinhardt, George Soros, Julian Robertson, Stanley Druckenmiller, Paul Tudor Jones, Bruce Kovner, John Paulson and Ken Griffin.
Many of their tales are already well told; several have multiple books dedicated to their exploits. But Mallaby manages to dramatise even heavily raked-over incidents, such as Paul Jones’s anticipation of the 1987 stock market crash, or George Soros’s successful assault on the Bank of England in 1992. He gets into the minds of the traders (“All I want to do is kill myself,” one minion told Michael Steinhardt after a losing investment; “Can I watch?” came the reply), and adds extensive historical and academic context without interrupting the highly readable narrative.
Hedge fund managers may be attracted by Mallaby’s twin conclusions: “Governments must encourage hedge funds”; and “Don’t regulate” (he would relax this decree for the very largest, leveraged funds). But the stories he tells of how hedge funds made money could equally be used by German and French critics to support their calls for a clampdown as they negotiate final details of new European rules. Insider trading, market abuse and straightforward fraud leap out of the pages, from the very first days through to the recent arrest of Raj Rajaratnam, founder of US hedge fund Galleon Group. As Mallaby says of Rajaratnam, accused of running an insider trading ring, “He had no amazing special sauce, but he had a lot of special sources.”
Mallaby makes clear that hedge funds are, at best, as pure as the driven slush. But he makes no apologies. “The case for believing in the industry is not that it is populated with saints but that its incentives and culture are ultimately less flawed than those of other financial companies,” he argues. For anyone unconvinced, he puts a lot of weight on the fact that during the recent crisis hedge funds managed to collapse – at the rate of 1,500 a year in 2008 – without government bail-outs. They were small enough to fail, unlike the too-big-to-fail banks.
All the common critiques of the industry are addressed, from the trend-followers’ tendency to amplify market moves to hedge funds’ failure to consider liquidity issues (an expensive lesson for several of these latter-day masters of the universe).
There are two points of weakness in Mallaby’s argument. First, he fails to deal effectively with the claim that hedge funds are too expensive. This is not just a matter of social envy. In the discussion of the best method of allocating scarce capital, the cost of the system chosen – the fees, in the case of hedge funds – is clearly an essential consideration. Mallaby attempts to contrast the industry standard fee of 2 per cent of assets a year and 20 per cent of a fund’s profits with investment banks paying half of turnover to staff. But revenue at a bank is a tiny fraction of assets, and even if it were comparable to hedge fund fees, which it is not, critics of hedge fund fees are hardly likely to be won over by comparisons with clearly overpaid investment bankers.
Second, he skates over the problem of crowded trades, when all the hedge funds are doing the same thing. This is one of the major concerns of regulators: while no individual hedge funds may (for now) be too big to fail, a large number of simultaneous failures of small funds could take down a bank and start a new crisis.
Picking holes in the argument is really an aside to this splendid account of the ups and downs of an industry in which few of the twenty-something hedge-fund wannabes know their history. They, and meddling politicians, should read this book before they are condemned to repeat it.
James Mackintosh is the FT’s investment editor