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THE GOLDEN AGE OF THE HEDGE FUNDS ENDED THIS SPRING
Edge funds were among the most powerful and controversial players in the international financial markets of the 1990s. The biggest among them, notably George Soros and the Quantum Fund, could and did more even such global, liquid markets as foreign exchange and bullion. The biggest player in the US Treasury bond market for much of the 1990s was not a Wall Street investment bank or central banks such as the Bank of Japan or Saudi Arabia's Sama but a secretive hedge fund in Greenwich, Connecticut, run by Nobel laureates and rocket science mathematicians called Long Term Capital Management (LTCM). The power and global impact of the hedge fund kings in the 1990s can hardly be overemphasised. George Soros played a major role in sterling's fall from grace from the ERM in 1992. During the Asian crisis of 1997-98, Soros made global headlines when Malaysian Prime Minister Mahathir Mohamed accused him and his ilk of deliberate financial sabotage of South-East Asians currencies. LTCM made financial history in the matter of its collapse. With $400 billion in leveraged funds borrowed from the biggest banks on Wall Street, the Fed was forced to engineer a bailout of the crippled LTCM, the first time in capitalism that a central bank bailed out a hedge funds in distress. The modus operandi of the hedge funds was simple enough. A handful of hedge funds, led by the Hungarian billionaire, Soros, raised a few billion dollars from secretive offshore clients, leveraged their funds assets with credit lines from banks in Wall Street and used their financial power to bet on anything from Swiss francs and Treasury bond options to silver and Euro dollars futures. These funds are known as the global 'macro' hedge funds because their managers make leveraged bets on currencies, interest rates, stock market indices, oil and commodities. The golden age of the hedge funds was in the early 1990's when the currency markets were abuzz with the financial fallout of the Berlin Wall and the ERM, while the stock markets of the US and Europe were listless. In September 1992, George Soros became a financial celebrity overnight when his flagship fund Quantum took on the Bank of England and John Major during the ERM crisis with a huge leveraged bet against sterling. While Chancellor of the Exchequer Norman Lamont tried to borrow $15 billion to defend sterling, the Quantum Fund's $10-billion short position in sterling forced HM Treasury into the most humiliating devaluation by Britain in modern times. Soros not only broke the Bank of England, he bragged about it in public, thus creating a personality cult that resonated across the high-tech dealing rooms of Wall Street and the world financial markets. Investors all over the world rushed to invest in hedge funds who boasted the pedigree of George Soros, Julian Robertson of Tiger Asset Management and John Meriwether's Long Term Capital Management. The mid-'90s was the apogee of global macro investing. The dollar sank to ´79. The ERM withstood bouts of speculative attacks. The US Treasury bond market became the crucible of hedge funds devoted to the arcane art of leveraged international rate arbitrage. Even though hedge funds skinned their investors alive with huge management and performance fees and minimal disclosure there was no shortage of lambs willing to be led to the slaughter as long as the fund manager was a media superstar. George Soros himself epitomised this new breed of leveraged financial buccaneers. He gave interviews to the Financial Times that moved the markets in gold and currencies. He jetted around the world to meet kings, presidents, prime ministers and central bank governors. He dominated the international debate on issues as diverse as the fate of the Euro, the finances of post Cold War Russia, ethnic carnage in Bosnia and, bizarrely, even the need to curtail anarchistic speculators in the capital market! Soros no longer managed money. He pontificated on Big Ideas as the undisputed king of the new world financial order. The hedge fund parade hit an iceberg in the fall of 1998, when Russia defaulted on its sovereign debt and the Asian tiger currencies became pussycats en masse overnight. Malaysian Prime Minister Mahathir Mohamed blamed Soros and his ilk for the chaos in the South-East Asian financial markets. Unfair. The South-East Asian markets were casinos filled with sleaze, debt, borrowed dollars, phony asset bubbles, political games incompetent regulators and self-serving bankers. But Soros got tagged with the same brush as an earlier generation of British socialists who fulminated against the "Gnomes of Zurich" for the international crises of the pound sterling. Mahathir blamed Soros, the IMF, the World Bank and the tooth fairy for the Asian currency meltdown. Yet amid the international uproar, a volcano was poised to erupt in the game of international finance - and the epicenter of this volcano was not in Kuala Lampur but Greenwich, Connecticut. Salomon Brothers had a star trader named John Meriwether who made a fortune in the bond market. He formed his own hedge fund LTCM after being forced to resign from Solly in a T-bond auction scandal. LTCM was no run of the mill hedge fund. Its partners included Nobel laureates, ex-governors of the Federal Reserve Board and finance professors from Harvard and Wharton. It used complex mathematical models to make money from spreads among dozens of credit markets, from Danish mortgages to Japanese off-the-run public paper. The world's biggest banks were so enamoured of Meriwether that they allowed him to leverage LTCM capital 400 times over. When Russia exploded, so did Meriwethers portfolio. The bankers rushed to the Fed protect the system. The Fed obliged. The world financial system survived after history's first central bank rescue of a hedge fund. The golden age of the hedge funds ended this spring. Julian Robertson's Tiger Fund decided to liquidate after painful multi-year losses. George Soros also had to swallow a bitter pill. Stan Druckenmiller and Nick Roditi, the managers of the Quantum and Quota Funds, both resigned after a 25 per cent hit in tech stocks. Soros said he is going to become "conservative" in managing money. Hedge fund managers who are successful are far more conservative in their aspirations. They tend to use conservative leverage ratios because the Fed has made it clear to the bank that it will never allow the Himalayan ratios that sank LTCM and almost led to a banking crisis in the fall of 1998 to happen ever again. There has been a greater emphasis on risk management as investors have learnt the hard way that market neutral is not risk neutral. Hedge fund managers who succeed in raising vast pools of capital must demonstrate not just that they achieved high returns but what kinds of risks they took to achieve their performance. In fact, a cottage industry of consultants has evolved in London and New York to advise institutional investors how to design a portfolio of hedge funds to offer risk-controlled absolute performance. Leveraged macro bets are out of fashion. Hedge fund managers must now demonstrate core competencies in a specialist niche of the capital markets, such as long/short technology or convertible bond arbitrage. The idea is to generate absolute returns, adjusted for risk, using strategies that build on a manager's specialist focus or deal flow. These new breed of managers may not have the global clout of a Soros or a Meriwether. They do not exist to take on the Bank of England or Third World heads of state. But that is not altogether a bad thing anyway!
MATEIN KHALID The opinions expressed by the writer are his own and not endorsed by Press Release Network.
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