One of the most notable followers of Jones was Warren Buffett, then a small-time Nebraska investment manager. Buffett read the article on Jones and immediately decided that this was the way he wanted to run his own funds. He thus converted his Buffett Partnership, Ltd. into a hedge fund, and in the next few years he compiled a record of returns that was even better than Jones’s. Today Buffett is by far the largest of the hedge fund managers, with a pool of assets in the $100-million range. He is also the most successful, having compounded his investors‘ money at an extraordinary 29 percent annual rate since 1956. This is a record that, given the length of time involved and the fact that Buffett has taken no risks with borrowed money, may be without parallel in investment history.
When the SEC began its investigation of the hedge funds last year, one of the things it was doing was investigating Buffett. The commissioners had received a complaint from a New York broker that Buffett had bought into a number of small companies in the past few years and then had tried to manipulate their stock prices upward. The SEC’s investigators found that there was no substance to the complaint, but in the course of their inquiry they did discover something else: Buffett had been using a curious new technique to enhance the effect of his investments. The technique, which Buffett calls „The Arbitrage of Takeovers“ and which others have come to refer to as „The Arbitrage of Buffett,“ has since become a standard part of the hedge-fund manager’s repertoire.
Buffett’s idea, in essence, is to buy small companies that are in takeover situations, and to sell short the stocks of the companies making the takeover bids. When the takeover goes through, the stock of the target company ordinarily jumps, while that of the bidder usually declines. The result is a double profit for Buffett, and this was the idea that so impressed the SEC. It is not clear, however, that the arbitrage of Buffett is a device that can be widely employed. Buffett himself has said that he believes there will always be takeover situations available for the enterprising investor, but his own record with the technique has been so extraordinary that he may well have squeezed the last drop of profit from it.
Whatever the prospects of the arbitrage of Buffett, there is no doubt that the hedge funds will continue to thrive. The initial impact of the SEC’s investigation was a setback for the funds, but the SEC has not yet moved to regulate them, and it is not at all certain that it ever will. In the meantime, the funds have been attracting more and more money from investors, who are drawn by the high returns the funds produce and by the glamour that surrounds their managers. There is no shortage of would-be hedge fund managers, and the prospect exists that there will soon be a hundred or more funds operating in the United States alone. The hedge fund establishment may not welcome this development, but it is certainly not unhappy about it. It is still a long way from the size of the mutual fund industry, but as things stand, it is the most exciting game in town.
Some investors are wealthy individuals who have made their money in various ways: e.g., James Linen, of the textile family; George Weyerhaeuser, of the timber dynasty; E. Kendall Adams, the Wall Street broker; David Rockefeller, of the Standard Oil clan; Laurence Rockefeller, of the Chase Manhattan Bank. Still others are members of old families, such as the du Ponts, the Mellons, the Whitneys, and the Fords. A few are foreign nationals, for example, the Honorable A. G. E. P. Fane, a director of the Bank of England; and Sir John Maffey, the British Ambassador to Dublin. The list could go on indefinitely. At the same time, it should be pointed out that the average investor is not especially well-to-do. In fact, many are professionals of one kind or another — doctors, lawyers, architects, engineers — who have managed to accumulate a good deal of money in their own right.
Some hedge funds have taken in money from institutions, including a few banks and insurance companies. But the number of institutions investing in these funds is still small — no more than thirty. The reason for this is simple. Institutions can make more money by investing their excess funds in government securities than they can by dabbling in the securities markets, which are risky. Consequently, the bulk of the money that has gone into hedge funds has come from individuals. But as the funds have grown in size and respectability, institutions have shown more interest in them. In some cases this has been due to the fact that institutions have been persuaded by the more established businessmen who have invested in the funds to join them. In others it has been due to the success of the funds themselves, for there are several hedge funds that have shown a remarkable ability to make money, and the more enterprising institutions have begun to take note of this fact.
One such institution is the National Bank of North America. Last year the bank took a substantial position in one of the smaller funds, and since then has contributed to the setting up of two new funds, one of which is expected to be the largest hedge fund of all, when it opens its doors for business. The new fund will be run by two young men, who have been given a great deal of leeway by the bank. They are expected to take the sort of risks that have made hedge funds the success they are today, and the bank has promised them a share of the profits they earn on the money they invest. This is the first time that a bank has been so directly involved in the management of a hedge fund, and the experiment will be watched with interest by the financial community.
For the most part, however, the hedge funds are still strictly professional operations, run by men with many years of experience in the securities markets. The average age of the general partners is around forty-five, and the average length of time they have spent in the business is close to twenty years. Some are former floor traders who have accumulated a lot of money and decided to go into business for themselves. Others are former stockbrokers who have made a good deal of money by trading on their own accounts, and have decided to set up their own funds. A few are former research analysts who have become convinced that they can do better by managing money than by writing reports. And a very few are former investment bankers who have decided that there is more money to be made in managing than in underwriting. The one thing they all have in common is a belief in their ability to make money in the securities markets, and a willingness to take the risks necessary to do so.
There is, however, one general partner who stands out from the rest. His name is Warren Buffett, and he has made a great deal of money for his limited partners in the past few years. His fund, Buffett Partnership, has tripled in size since 1964, and is now one of the largest hedge funds in existence. Buffett is a former stockbroker who has made a great deal of money by buying and holding undervalued securities. He has a reputation for being one of the best stock pickers in the business, and his limited partners have benefited from his ability to find bargains in the market. Buffett is also one of the few general partners who has not been afraid to take large positions in the market, and his willingness to do so has paid off handsomely for his limited partners. In short, Warren Buffett is the kind of general partner that every hedge fund investor dreams of finding.
How long this kind of success can continue is an open question. Some people believe that the hedge funds are bound to run into trouble sooner or later, because they are taking too many risks with other people’s money. Others believe that the hedge funds will continue to prosper, because their general partners are among the smartest and most experienced investors in the business. The truth probably lies somewhere in between. The hedge funds are not likely to go away, because they have filled a need in the market that no one else has been able to fill. But they are also not likely to continue to make the kind of money they have been making in the past few years, because the securities markets are always changing, and what works today may not work tomorrow. In the end, the hedge funds will probably survive, because they are run by men who know how to make money, and are not afraid to take the risks necessary to do so. And that, in the final analysis, is what investing is all about.
Jones now says he will never forget 1969, and he has returned to his old ways. He has abandoned the idea of running at full risk all the time and has gone back to what he knows best — a balanced approach, with hedge strategies for the bad times and full risk only when the market trends are favorable. His funds are once again fully hedged. Jones’s returns have improved, but he is not back to his old highs. His grief is partly monetary in that he has lost some money and has seen his funds drop in the rankings, but it is also personal. He feels that he let his partners down. Yet he says only a few of them have bolted. Most have stayed with him, and some have added more money to their accounts to help him recoup his losses.
By the end of 1969, Alfred Jones was not the only hedge-fund operator who was feeling a personal sense of loss. A number of managers, some of whom had never before experienced a serious setback, were reckoning with the fact that they had been wrong about the market, and their funds were down from 20 to 40 percent for the year. Among them were two of the most experienced operators in the business — Warren Lichtenstein and Wallace Weitz. Both have been managing private hedge funds for more than ten years, and their funds, which are not listed publicly, have consistently been near the top of the performance tables. However, in 1969 both were caught off balance. Lichtenstein’s fund was down by 28 percent for the year; Weitz’s, by an even larger amount. Both are now back in the markets, trying to recoup their losses.
Some of the hedge-fund operators with the worst records for the year are now looking for other ways to recapture their losses. A few, like Jones, are returning to their old ways; others are looking for new strategies. One of the more interesting new strategies is that of John Hartwell, the investment counselor who has been collecting data on hedge funds. Hartwell has been managing two private hedge funds, one of which is a no-load mutual fund, the other, a leveraged fund. Both funds have been down for 1969, but only slightly. Hartwell says he is now looking for ways to increase his leverage, and he thinks he can do so profitably. He believes that the market is now at a point where it is possible to take advantage of the leverage that is available in the market.
While some hedge-fund managers are returning to their old strategies and others are looking for new ways to make money, still others are simply waiting for the market to turn around. Edward Lambert, who manages a small private hedge fund in Connecticut, says he has no plans to change his strategy. He believes that the current downturn in the market is only temporary, and that the market will soon be back on the upswing. Lambert says he has been through similar downturns before, and he has always come out ahead in the end. He says he is confident that he will do so again this time.
Despite the losses suffered by many hedge funds in 1969, the hedge-fund industry as a whole is still thriving. According to Lipper Corp., there are now more than 500 hedge funds in operation, with assets of more than $1 billion. And this number is growing every day. Many new funds are being formed, and many existing funds are expanding. The industry is attracting new investors, including individuals, pension funds, and other institutions, who are looking for ways to diversify their portfolios and take advantage of the potential for high returns that hedge funds offer.
As the industry continues to grow, it is likely that there will be more ups and downs in the market, and more losses for some hedge-fund managers. But for those who can weather the storms and stick to their strategies, the potential for high returns is still there. And for investors who are willing to take on the risks, the rewards can be substantial. In the world of hedge funds, as in the world of investing in general, there are no guarantees. But for those who are willing to take the risks, the potential rewards are great.
Jones’s decision to focus on moderate, steady growth rather than big swings was a significant shift in his investment strategy. This change was driven by the underperformance of his funds compared to the market average and the dissatisfaction of some limited partners with break-even years. Despite the challenges of short selling in a bear market, Jones maintained high short positions and continued to believe in the importance of hedging as a strategy for portfolio managers to operate successfully on the long side. While some investors questioned the value of short selling, Jones and his fund managers remained committed to the hedge fund concept and saw their struggles in 1969 as a reflection of their own abilities rather than the strategy itself. It is known that the SEC is considering requiring the funds to register as investment advisers and to abide by the same rules that govern mutual funds. This would mean, among other things, that the funds would have to disclose their holdings and trading policies to the SEC. It would also mean that the funds would have to pay the SEC a fee, which would be used in part to finance the agency’s efforts to keep an eye on the funds. The SEC would like the funds to be required to restrict their operations to those that are legal and proper, and to make no attempt to manipulate the market. It would also like the funds to be required to refrain from engaging in activities that could harm the public or the markets, such as spreading false rumors.
Many hedge-fund managers are not happy about these proposals. They see them as a form of governmental interference that could drive them out of business. They also see them as a threat to their profits, since the funds would likely have to pay higher fees if they were regulated by the SEC. Moreover, they see them as a threat to their privacy, since they would have to disclose their holdings and trading policies to the SEC. Some of the managers have been talking about suing the SEC if it goes ahead with its plans. But others have been more conciliatory, saying that they would be willing to abide by the new rules if they were applied fairly and evenly to all the funds. It remains to be seen how this debate will play out, but it is clear that the hedge-fund business is at a crossroads, and that its future is uncertain.
One thing that is certain is that the hedge-fund managers are going to have a hard time convincing their investors to stick with them. The investors have been disappointed by the poor performance of many of the funds last year, and they are worried about the possibility of further losses. They are also concerned about the possibility of government regulation, which could reduce the profits of the funds. Some of them may decide to pull out of the funds altogether, and to put their money into other investments. Others may decide to stick with the funds, in the hope that they will eventually turn things around. But it is clear that the managers are going to have to work hard to win back the trust of their investors, and to prove that they deserve to be entrusted with their money.
In the end, the fate of the hedge-fund business may depend on the ability of the managers to adapt to changing circumstances, and to find new ways to make money in a difficult market environment. Those who are able to do so may survive and prosper, while those who are not may be forced to close their doors. It is a challenging time for the hedge-fund industry, but it is also a time of opportunity. Those who are able to rise to the occasion may find that they are able to thrive, even in the face of adversity.
Another possible route the SEC is considering is to argue that the hedge funds are investment advisers. The Investment Advisers Act of 1940 requires registration of investment advisers who counsel others on the purchase or sale of securities. The SEC staff believes that hedge funds, in advising their limited partners on when to buy and sell securities, fall into this category. If the SEC is successful in establishing that the hedge funds are investment advisers, they would need to register under this act as well.
Ultimately, the SEC is faced with a challenging task of figuring out how to regulate hedge funds, which have been operating largely outside of its regulatory purview for many years. The findings from the questionnaire sent out to investment partnerships will likely play a significant role in shaping the Commission’s approach to regulating hedge funds in the future. Anwälte der Hedgefonds schütteln den Kopf und sagen, dass alles lächerlich ist, aber sie sagen auch, dass schlimmere Dinge den Hedgefonds passieren könnten. Vielleicht, wenn es die SEC von ihrem Rücken nehmen würde, sagte kürzlich ein Anwalt, sollten die Hedgefonds gestehen, Händler zu sein, obwohl sie sicherlich nichts dergleichen sind. Was hat Heinrich IV gesagt? „Paris ist eine Messe wert.“
In Hedgefonds-Terminologie ist Paris die 20 Prozent der Gewinne, die an die Generalpartner gehen, und wenn diese einen anderen Kurs verfolgen würden, könnte Paris einfach verschwinden. Dieser Kurs würde die Kommission dazu bringen zu behaupten, dass die Generalpartner in Wahrheit Anlageberater sind, ein Begriff, der sich gemäß dem Investment Advisers Act von 1940 auf jede Person bezieht, die gegen Entgelt im Geschäft des Beratens anderer [in Bezug auf ihre Investitionen] tätig ist. Das SEC-Personal argumentiert, dass jeder, der Geld auf diskretionärer Basis verwaltet, wie die Generalpartner eines Hedgefonds dies eindeutig tun, zwangsläufig auch diese Investoren berät.
Auch die Anwälte der Hedgefonds finden dieses Argument schwer anzugreifen, aber sie haben es versucht. Sie sagen, dass eine Anzahl von Investmentpartnerschaften existierte, als der Adviser Act verabschiedet wurde, und dennoch ignorierte das Gesetz ihre Anwesenheit. Sie sagen auch, dass die unbegrenzte Haftung, die die Generalpartner in einer Kommanditgesellschaft übernehmen, und das von ihnen üblicherweise eingebrachte Kapital sie zu mehr als Beratern machen. Schließlich verweisen sie auf eine Klausel im Gesetz, die besagt, dass jeder Berater mit vierzehn oder weniger Kunden von der Registrierung befreit ist; selbst wenn die Generalpartner Berater sind, sagen ihre Anwälte, sind ihre Kunden nicht die Kommanditisten als Einzelpersonen, sondern der Fonds als einzelne Einheit. Mit anderen Worten, sie haben nicht die Anzahl von Kunden, die sie zur Registrierung verpflichten würde.
Auf die Gans zielen
Das gesamte Argument hat ziemlich verzweifelte Untertöne für die Generalpartner, denn sie können keine Registrierung als Anlageberater tolerieren. Der Advisers Act verbietet jede Art von Vergütungsvereinbarung, die die Gebühr des Beraters mit den Ergebnissen verknüpft, die er mit dem Geld seines Kunden erzielt. Diese Verbotsklausel wurde in das Gesetz aufgenommen, um Spekulationen zu entmutigen, denn die SEC glaubte damals – und im Allgemeinen immer noch -, dass Berater dazu verleitet würden, mit dem Geld ihrer Kunden übermäßige Risiken einzugehen, wenn sie einen Teil der Gewinne einstreichen würden, aber gleichzeitig von Verlusten ausgenommen wären. Man kann argumentieren, dass das Verbot jeden Anreiz des Beraters zerstört und daher unklug ist oder zumindest zu weitreichend ist. Dennoch besteht das Verbot, und in Bezug auf die Hedgefonds bedroht es sicherlich die Gans, die die goldenen Eier gelegt hat.
Wenn die SEC jetzt ihre Gedanken in die Tat umsetzen und den Hedgefondsmanagern des Landes mitteilen würde, dass sie von diesem Tag an als Anlageberater identifiziert werden sollen, würden die meisten sich nicht unter dem Gesetz registrieren. Stattdessen würden sie ihre Hedgefonds schnell in registrierte Investmentgesellschaften umwandeln. Dadurch würden sie ihre Fonds bestimmten restriktiven Regeln in Bezug auf Leerverkäufe und Hebelwirkung unterwerfen und traurigsterweise die glorreichen Steuervorteile verlieren, die für Partnerschaften gelten. Aber registrierte Fonds dürfen mit Erfolgsgebühren arbeiten, und so könnten die Manager einige Merkmale ihres alten Lebens retten.
Es ist schwer zu sagen, was die SEC tun wird, und es ist sogar schwer, eine Meinung darüber zu bilden, was sie tun sollte. Wahrscheinlich verdienen die Hedgefonds in irgendeiner Weise reguliert zu werden, aber ob sie verwüstet werden sollten, ist eine andere Frage. Wenn wohlhabende, anspruchsvolle Investoren 20 Prozent ihrer Gewinne für Anlagemanagement zahlen möchten – oder, wie es ein niedergeschlagener Investor ausdrückte, dumm genug sind, 20 Prozent zu zahlen -, dann sollten sie möglicherweise dazu berechtigt sein. Wie auch immer, es könnte sein, dass nach 1969 nicht mehr so viele in dieser großzügigen Stimmung sein werden. Denn wie jeder Hedgefondsmanager weiß, kommt man auf dem Markt ohne ein gutes Produkt zu einem guten Preis nicht weit.