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Investment guru with the world on his sh... High-flying market maker gets too close ... |
High-flying market maker gets too close to the sun
In the wake of the bailout of the US fund LTCM, ANDREW CAVE looks at what makes a hedge fund tick
IN THE game of Monopoly that occupies Wall Street, investing in a hedge fund can be rather like players picking up Chance or Community Chest cards. Hedge funds often take large risks on speculative strategies and investments in them can have dramatic consequences. They play in all financial markets. However, their major play involves derivatives, which they use to leverage every trading position they hold. They may have a small capital base but their total exposure to financial markets can be 20 to 30 times as big. They often make their biggest profits when trading in turbulent markets with sharply declining prices, and because they move billions of dollars in and out quickly, they can have a significant impact on stock, bond and futures markets. All this makes hedge funds one of capitalism's more spectacular instruments and their managers, such as George Soros and Tiger Management's Julian Robertson, tend to be flamboyant high-profile characters. Long-Term Capital Management (LTCM) is one of the foremost examples of this characteristic. Only six years old and smaller than the Soros and Tiger funds, LTCM has an impact on markets out of all proportion to its size because it employs very high levels of leverage. The fund is secretive about its operations, even with its own investors, but it made a name for itself with complex billion-dollar bets on the differences between interest rates on various bonds. Its 12 partners put in $150-million when the fund management firm was established in 1992. This grew to $490-million by last year as the capital base of $1.25-billion mushroomed to $6-billion. The returns for investors, which include many leading Wall Street bankers, were excellent, enjoying an average annual return of 28.7% after costs. This summer, however, the crises in Russia and the Far East led to widespread turbulence in global markets. After six years of success, Long-Term had played the wrong card. Swiss banking group UBS became the first major institution to reveal that it had been hit by the near collapse of LTCM. UBS will take part in a 15-bank syndicate, which includes Barclays, Goldman Sachs and Merrill Lynch, that will invest $3.5-billion in the fund to rescue it. LTCM said the new equity would lift net asset value to above $4-billion and provide sufficient liquidity to manage positions and stabilise the fund. The Swiss bank has set aside Sf950-million cover its investments in LTCM. The charge does not include UBS's $300-million contribution to the rescue package. One banker said: "Bankers used to fall over themselves to deal with Long Term because they thought the guys who ran it were so brilliant. The trouble is that they began to believe their own PR. I think they lost the plot; the market is always cleverer." The fund, which predominantly invested in G7 countries, was hit by the flight to quality that followed the Russian crisis. This threw long-standing relationships between different financial markets out of kilter and it meant that computer models, used by Long Term as a basis for its investment strategy, could not cope. LTCM does not rank high up the list of the world's largest hedge fund managers but it tops the league for star quality. Its founder, John Meriwether, was one of the most successful "Masters of the Universe" at Salomon Brothers in the 1980s and LTCM, his creation, is the only hedge fund to be able to list multiple Nobel laureates on its lettered notepaper. Meriwether figured prominently in Liar's Poker, the bestseller that portrayed the swaggering boomtown culture at Salomon during that decade. According to the book, he was challenged to a "$1-million bet, no tears" by Salomon's chairman, John Gutfreund. Meriwether replied: "I'd rather play for real money. $10-million. No tears." Meriwether launched LTCM in the quiet surroundings of Greenwich, Connecticut, after he left Salomon in August 1991, taking responsibility for a Treasury bond-rigging scandal. He took with him top traders at Salomon such as former Harvard business school professor Eric Rosenfeld and Larry Hilibrand, who was reported to have taken home a $23-million pay cheque from Salomon in 1990. Meriwether also recruited former Federal Reserve vice-chairman David Mullins. Meriwether's team is renowned for dressing in chinos and polo shirts rather than the stiff Wall Street uniform of business suits. But what put LTCM on the map was Meriwether's "dream team" which entrusted top academics with the task of using highly complex mathematical formulae to exploit arbitrage opportunities in the market. Harvard professor Robert Merton and Californian academic Myron Scholes later won the $1-million Nobel Economics Prize in 1997 for devising and developing the "Black-Scholes Model" of determining the value of derivatives. The Nobel jury said their work on the model with Goldman Sachs' partner Fischer Black, who died in 1995, "stands out among the foremost contributions to economic sciences over the past 25 years". - The Daily Telegraph. Top of page
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