Hedge funds get rich on the back of the world's financial blunders
In the old days, technical books were read for one's education, but they were so boring that you would fall asleep. You read novels instead for their drama, romance and excitement. In this fast-moving world, where daily events are more thrilling than fiction, books like More Money than God by Sebastian Mallaby are real page-turners.
Written by a former journalist, who today works for the US Council on Foreign Relations, the book combines blood-and-guts story-telling with careful analysis of the hedge fund industry. The narrative is so thrilling that when the author described the scene where the hedge funds took down Thailand in 1997, my hair stood on end.
If you want to know how hedge funds sniff out opportunities by talking to honest and naive central bankers, then go on to make more money than God, read this book. It is both a clinical analysis of how hedge funds emerged from nowhere to become the market movers of today, and a morality story that raises more questions than it is able to answer. It may not be illegal (at least under existing law) to do a trade that tips a nation into abject poverty because there were tragic policy mistakes, but is it morally right to take home billions by accelerating the process of 'creative destruction'?
The central insight of the hedge fund industry is brilliant - it is that the academic theory about finance is all wrong. Modern finance theory begins with the assumption that the market is efficient and knows best. The efficient-market hypothesis is based on the view that it is not easy to beat the market. However, the hedge fund industry makes most money from the inefficiencies of the market. If you are not convinced, look at how, between May 1980 and August 1998, the Tiger Fund - a hedge fund founded by Julian Robertson - earned an average of 31.7per cent per year after fees, beating the 12.7per cent return on the S&P 500 index. The offshoots of the fund generated returns of 11.9per cent per year between 2000 and 2009, compared with the average of 5.3per cent per year for the S&P index.
Mallaby takes the story from the 1949 creation of the first hedge fund by Alfred Winslow Jones to the emergence of a sophisticated and complex US$2trillion industry. He weaves a wondrous tale of how tribal and interconnected the industry became as it emerged.
Nobel laureate Paul Samuelson, famous for arguing that randomly chosen stock selection would beat professionally managed mutual funds, was a founder investor of the Commodities Corporation, and one of the first quants, using computer analysis to trade commodities. The Commodities Corporation was the nursery for three future hedge fund giants, Bruce Kovner (Caxton), Paul Tudor Jones (Tudor Investments) and Louis Bacon of Moore Capital. Bacon had connections with two of the 'Big Three' in the early 1990s, being related by marriage to Robertson and having worked briefly with Michael Steinhardt. The last of the Big Three was George Soros (Quantum Fund), who became famous as the man who made GBP1 billion (HK$12.1 billion) speculating in sterling, and is now also known for his philanthropy.