Hedge Fund Democracy Claims More Funds

When investors head for the exits, managers suddenly see their mountain of assets shrivel to a little pile.


You can say this for hedge funds: More than most other businesses, they most embody the capitalist system. You do well, you make a lot of money.

You screw up, you don’t do so well. It is democracy — hedge fund style. The old ‘eat what you kill’ mentality. “It is all about performance,” GLG co-CEO Manny Roman recently told me. “It always has been.”

I know there are flaws to this system, especially in this 2 and 20 era. Large hedge fund firms with billions under management still make tens of millions of dollars on management fees even if they don’t make money from investing.

And the lack of clawbacks enable people like Eddie Lampert to make more than $1 billion in 2006 and 2009 (including gains from his own capital in his fund) even though he was down 27 percent and 25 percent in the two intervening years. Sure, he lost money on his own stash of cash in the funds, but he did not have to give back any of the fees he made in earlier years.

In any case, what I especially like about hedge fund democracy is what happens when managers screw up: Investors head for the exits and suddenly managers see their mountain of assets shrivel to a little mound. This rarely happens with mutual funds, or with the ferocity experienced at hedge funds.

We are reminded of this in recent days and months in a number of ways.

For example, last week we learned from sister publication AR-Alpha that Paolo Pellegrini, the guy who was most credited (but not most compensated) for John Paulson’s bets against the housing market several years ago, is returning all outside client money from his firm PSQR Capital after his Master Fund was down about 11 percent through the end of July. “While my views on global economies haven’t changed, I’ve concluded that substantial additional work is required to position the Fund to profit consistently from those views,” the investor reportedly wrote.

Call this a preemptive strike before his investors submitted their redemption requests en masse.

We also recently learned that a number of people recently left Millennium Management. Some press reports speculated that this probably reflects a downsizing of the firm founded by Izzy Englander.

Very doubtful. More likely, these guys were not exactly the stars of the outfit. As anyone who has met Izzy even casually knows, this guy lives and breathes the ‘eat what you kill’ mentality, as well as ‘die from what you can’t overpower.’

In fact, he is known for canning people after a week or two on the job if he simply discovers they are investing differently than advertised during their job interviews.

Then there is Clarium’s Peter Thiel, best known for co-founding PayPal and for his early investment in Facebook. He wanted to add star hedge fund manager to this list. But, alas, this isn’t happening.

Like the doctor and dentist who think they can invest on their own, Thiel thought the same brain than made him a billionaire investing in innovative, nascent technological advances would enable him to equally succeed trading the market. Wrong. This year he is down once again, by double digits, and assets have shrunk nearly 90 percent, to less than $1 billion, from a peak of around $7.2 billion.

Another hedge fund whose investors are bailing out when performance went sour is London-based Polygon Investment Partners. Founders Reade Griffith and Paddy Dear suspended withdrawals from their $3.7 billion Global Opportunities Fund in October 2008, saying it would take four years to unwind the fund, according to Bloomberg. Now, there are reports they are allowing investors to take out their money two years earlier, provided they do it at a 25 percent discount.

The wire service says Polygon Global Opportunities fell 48 percent in 2008, mostly due to bad bets on convertible bonds.

Gotta love hedge fund democracy.

Stephen Taub

Stephen Taub

Stephen Taub, who has covered the hedge fund industry for 30 years, is a contributing editor to Institutional Investor and Absolute Return-Alpha magazines.