Sunday, December 17, 2006


You can smell it in the air. The scent of the yule log burning, egg nog heavily spiked, the sap of the Christmas tree. And the strongest odor of all is that of money. Money! Money! Money! Bonus time! It's been a good year on The Street and everybody is getting into the Christmas spirit of crass conspicuous consumption. Sure, most everybody made good money this year. But over the past few years, the divide between those at the top of the pyramid and the rest is wider than ever. In fact, the top are not even on the pyramid; they're sitting atop Mt. Olympus. Never have so few made so much. Once upon a time, the top dogs had an annual take of $20 to 30 million. Now, that number is $300mm, $400mm, $500mm, maybe higher. What in the name of old St. Nick is going on?

Yes, the markets overall have had a decent year. But the markets had much better years in the 80's and 90's and guys didn't take home that kind of stupendous, mind boggling pay. No, what has happened is that money managers have somehow managed to game the system so that their take has increased ten fold. And the vehicle that has driven them to financial nirvana is the hedge fund.

Ten years ago, there were a few hundred hedge funds managing around $100 billion total; now there are over 8,000 managing over a trillion dollars. It's not hard to understand why money managers would opt to go hedge fund. Mutual fund managers get a little over 1% of total assets managed as their take, while hedge fund managers get that as well as 20% of the gains. And investors once had good reason to put money into a hedge fund. Back when there were just a few hundred funds, the returns generated by hedge funds usually beat market indicies by a wide margin. If the S&P, for example, returned 10%, hedge funds might generate upwards of 30%. That's how good the relatively few guys in the game were back in the late 80's and early 90's. Guys like Paul Tudor Jones and George Soros. And so investors, mostly individuals with high net worths, vied to get into these exclusive clubs.

The game changed when institutions decided that "alternative investments" such as hedge funds made sense for them as well. All of a sudden, trillions of dollars were available. The response to this exponential increase in the investor base was a exponential increase in the number of hedge funds to service it. But increase in quantity does not mean increase in quality, and among the thousands of new hedge fund managers were very few Paul Jones or George Soros. Call it the dumbing down of the hedge fund industry. And so many managers chasing so few good trading ideas has resulted in lesser returns for everybody, including the most talented traders.

One would have to go back to the days of the Robber Barons to find a similiar time of wealth creation. But Rockefeller, Carnegie, Frick, et al made their dough by creating something of real economic value, such as a national rail system or the steel industry. The newly mega rich today have developed no new technology or new industries, but are money changers. We don't make "things" anymore, we make markets. And many of the newly minted hedge fund newbies are not really good even at that. Whereas hedge funds in the beginning would easily beat the market indicies or trounce their mutual fund brethern, over the past few year hedgies in general haven't beaten the S&P. This year hedge funds will average 11% return, not even keeping pace with the stodgy old Dow, which is up over 16%. Kind of pathetic.

And yet over this same period, the hedge fund gang has amassed riches that were unthinkable ten years ago. Forty something year old centillionaires, even billionaires with five, six, seven mutli-million dollar homes scattered all over the globe, hosting private parties with the Stones as entertainment, spending millions on fine art which they don't really understand, hundred of thousands spent every year on jewelry, spas, electronics, dropping $10,000 on a bottle of get the picture. Everybody on the mutual fund side, everybody on the sell side, everybody and his brother and cousin are angling to get in. I know nincompoops I wouldn't trust with my savings account who are now trying to start up hedge funds. It's like these guys wake on Saturday morning with a to-do list: 1) laundry 2) get haircut 3) start hedge fund. Guys who don't have a clue but who know that if they can amass say $100mm in assets, then the 2% "management fee" gets them $2mm, for doing nothing, for just putting a shingle on the front door. And like I said before, most of these guys can't even beat the Dow. A lot of these guys can't even do better than a money market fund. But hey, 2% on $100mm and next thing you know $10,000 for a bottle of wine is no big deal.

So who ultimately is paying for all these nincompoops to get into the hedge fund business? The answer is even a bigger class of nincompoops, namely the public servants who run pension funds for state and city municipalities, the administrators of non-profit foundations, the bureaucrats who oversee university endowments. In other words, guys who are as far from Warren Buffet when it comes to investing as Gomer Pyle is from George Patton. DUMB MONEY. These guys used to be content investing with mutual funds charging 1-2% management fees. But now they can't resist the glamorous allure of hedge funds. Hobnobbing with the hedge fund swashbucklers partially makes up for their middling government salaries. You can picture these guys at the neighborhood barbeques, bragging about how they had lunch at the Four Seasons with some billionarie hedge fund titan.

The result has been one of the greatest transfers of wealth in generations. Money is being passed from old age pensioners, college students receiving aid, charities relying on foundations, literally orphans and widows to the fattest of the Wall Street Fat Cats. And hardly a word is uttered in protest.

The only bigger scam and racket that I can think if the Fund of Funds game. But don't get me started on that.......