More Mistaken Thoughts about Hedge Funds - A European Perspective

After taking a little break from the single stock write-ups for Wallstrip, I am once again reading the editorial pages and getting somewhat nauseous. My latest case of indigestion is from some friends over in Europe who seem to think that, well, we are all taking too relaxed a view about those big, bad, cataclysm-inducing hedge funds. This little missive is straight out of today's Financial Times. They've given me so many softballs here that I don't know where to start, but please, review the text below (PS. the highlighting is my own):

LETTERS TO THE EDITOR: Even the professionals don't know all hedge fund risks

By: By leke van den Burg and Poul Nyrup Rasmussen, Financial Times
Published: Oct 26, 2006

From Ieke van den Burg MEP and Poul Nyrup Rasmussen MEP.

Sir, Although the public debate about the economic impact of hedge funds has barely started, you seem to have already drawn your conclusion in your editorial of October 17: don't hedge them in! Charlie McCreevy, the European commissioner for internal markets, seems to be of the same opinion.

We would be inclined, though, to ally ourselves more with the serious concerns expressed by several leading regulators of the financial markets.

First of all, you tend to play down the Amaranth case as a minor incident. How can you be so sure that the well-regulated banking and securities sector is able to compensate for all the risks?

If competent authorities such as Jean-Claude Trichet, president of the European Central Bank, tell us that they neither fully understand the new complex products nor have full oversight about the possible domino effects of collapses of a larger size, how can we then be sure that bigger and more complex collapses can be carried by the regulated part of the market?

Second, it is questionable that professional and institutional investors know all these risks. Since they do not play with the money only of rich people, but also with the hard-earned money of pensioners and workers, we would be inclined to regulate and monitor these so-called professionals somewhat more closely, to prevent them from running after hype and the super-profits conjured up to them.

Third, the short-term interests of hedge funds have in too many cases ruined the long-term strategies of strong and sustainable companies, leaving them saddled with heavy debts and either split or merged for short-term gain. This is not what we would call better corporate governance and a more competitive European economy.

So, we see at least three reasons that much more research and analysis is needed. This makes your anti-regulation conclusion, "don't hedge funds in", irresponsibly premature!

Ieke van den Burg,

Socialist Group in the European Parliament (The Netherlands)

Poul Nyrup Rasmussen,

President, Party of European Socialists (Denmark)

Messrs. van den Burg and Rasmussen, I have no idea how many people you represent, but if it is more than 10 I am deeply concerned. Your comments - or should I say rhetoric - show a phenomenal lack of understanding of both the issues and any semblance of equanimity. There are pros and cons to everything, gentlemen, something which is sorely lacking in your analysis. Let's take your comments one by one:

1. Amaranth. Nobody that I've read has said that Amaranth was a "minor incident." I'd say that most of what's been written has been highly critical of the fund's management, poor oversight, weak risk management culture, as well as the incredible latitude provided multi-strategy hedge fund managers. These criticisms were appropriate, justified and necessarily sober. Further, it has brought intense scrutiny on multi-strategy hedge funds in general, and the due diligence performed by hedge fund consultants in particular. Again, the situation has given rise to much healthy criticism and debate.

What has NOT been written is that Amaranth has posed a systemic risk that has rippled through the financial (or even the energy) markets. Why? Because it hasn't. The fund made a lousy, mis-sized bet. Word got out. They got crushed. Those better able to take on the risks of the positions stepped into Amaranth's shoes. They did well. The markets barely hiccuped. So, my Dutch and Danish friends, chill out. You know not of what you speak.

Intermission: Using Jean-Claude Trichet as the barometer by which you judge the risks and appropriateness of oversight of the hedge fund marketplace? You've got to be kidding me. Only in Europe. Come on, boys. Get serious.

2. Professional money managers. Gentlemen, why have we so little faith? It's not very nice to speak of an entire class of people, even money managers, with so little respect. Be that as it may, if you have so litle regard for these people, what makes you think that regulators can do any better? In fact, given the wording of your criticism, it seems that if professional and institutional investors don't know all the risks they should be regulated - by regulators, who presumably, know all the risks? If these regulators are so smart, then why aren't they managing money, smart guys? Because they want to do a service for society and give up all that money? Ha - give me a break! At least money managers have some training and experience in, er, money management. Also, please don't bring the "women and children" argument out - why is it that 98% of the time I hear that is when I'm either speaking to or reading a tract from a Contentinal European?

We have a concept over here in the US that governs situations where people in the position of responsibility for others' (yes, women, children, elderly, etc.) monies need to comport themselves in a certain way: as a fiduciary. If someone is found to be in breach of their fiduciary duty, they are in big, big trouble. So, these people in positions of power are, in fact, regulated by a very powerful statute and held to a very high standard of conduct. Instead, you two would rather have a bunch of ill-equipped regulators looking over the shoulders of money managers and telling them what they can and can't do? Right. This should lead to fabulous performance and attract only the best people into the field - not.

3. The evil hedge funds destroying Corporate Europe. This is the best of all! If only European shareholders were lucky enough to have hedge funds forcing managements to act in economically rational ways. Your argument on this point is so weak and pathetic as to completely undermine everything you've said before. I really thought we'd moved beyond this creaky old protectionist thinking, but clearly I'm wrong. You are living in a global economy, boys, whether you like it or not. Good luck selling all that high priced stuff for export with artificially high wages, bloated management structures and restrictive work rules. And don't even purport to know what creating a "competitive Europe" means - I guarantee your protectionist plan would be shot down by almost every credible economist on the planet.

If a company's strategy was so great and so sustainable, it couldn't possibly be "ruined" by a hedge fund. The only way a hedge fund succeeds in restructuring a business is if the other shareholders go along - nobody is holding a gun to their head. Again, to repeat, existing shareholders (not to mention management, with the support of shareholders) would tell the hedge fund to go away if it was believed their recommendations would impair the value of the company's prospects and, therefore, its stock price. The reasons why hedge funds are sometimes successful is when they target a company that can do better, so much so that other investors join them in executing their plan. So get you facts straight, guys. You are so off-base on this one it is mind-boggling.

Sorry about the rant, but if I read one more piece of editorial puffery (it seems to be like a virus that is going around) about big, bad hedge funds I may lose my mind.