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| Hedge funds - committed to growth or still growing up? |
| Learning to love hedge funds |
The days when hedge funds lurked in the shadows, largely unnoticed by the majority of the market let alone the general public, are gone forever. While once they made the news infrequently, every day now brings a fresh headline about these often misunderstood investors. Never has the need for them to engage with the media and their stakeholders been more pressing. While the hedge funds retain what they might consider to be a dignified silence, their targets and an uninformed media are telling their story for them. It is the wrong story.
In the UK, retailer GUS cries that it is being "held to ransom" by "shadowy" hedge funds in a dispute over a bond buyback, while in the Netherlands ailing retailer Ahold refuses to talk to two activist hedge funds commonly described as "fierce" and "aggressive". In both cases, the hedge funds have maintained a public silence, while briefing journalists off the record. The secrecy is largely unnecessary as the funds have solid reasons for their behaviour which would find support among the vast majority of the investment community. Their covert approach only adds to the unwarranted suspicion surrounding their profession.
 | While the hedge funds retain what they might consider to be a dignified silence, their targets and an uninformed media are telling their story for them. It is the wrong story. |  |
Today, the term hedge fund has entered everyday life as a topic of conversation and a rich source of anecdotes rivalling those of the excesses of the nineteen eighties, when the bond traders detailed in Michael Lewis' classic book 'Liar's Poker' were king. But the term is poorly understood. They are often portrayed as the edgiest investors, using the most complex financial instruments to pay themselves and their backers handsome fees, while savaging public companies and jeopardising the health of the international financial system itself.
Clearly, if any industry and its members ever needed public relations assistance, this is the one, because the truth is a lot more straightforward and a lot less sensational. Hedge funds were originally designed to mitigate risk and have actually been around for nearly sixty years. Of the large number that come and go, only those who make the headlines in this notoriously secretive industry are remembered. As hedge funds become an increasingly important and permanent part of the financial community, they can no longer be ignored in the hope that they might go away. Hedge funds need to address head-on the misperceptions about them and the harmful generalisations about them. And companies and their advisers need to have a strategy for engagement. But first, they need to understand what they are dealing with.
Simply put, hedge funds are investment pools, typically organised as private partnerships. Their managers, who are paid on a fee-for-performance basis, are free to use a variety of investment techniques to raise returns and cushion risk. In 1949 Alfred W. Jones established in the United States what is widely regarded as the first hedge fund. Combining two investment tools - short selling and leverage - he demonstrated how these two inherently risky approaches could be combined to limit market risk. An industry was born and over the next few decades a modest number of hedge funds set up shop providing suitably qualified or 'accredited' investors with an opportunity to invest in a fund offering absolute returns regardless of market conditions.
Hedge funds started to enter the mainstream public's consciousness in 1992, when George Soros's Quantum Fund made a momentous bet against sterling, generating a $1 billion profit and earning Soros his moniker of 'the Man who broke the Bank of England.' Long Term Capital Management's (LTCM) spectacular blow up towards the end of the decade, requiring a $3 billion bail-out by the world's leading banks co-ordinated by the Federal Reserve, further fanned the flames of public interest. More recently the collapse of the Amaranth fund, after a one-way bet by an individual trader went horribly wrong, has shown how the image of the industry still needs to distance itself from the antics of its wilder fringes.
It is an undeniable fact that hedge funds wield considerable power and are simply a fact of life that public companies have to deal with. Attracted by the aggressive compensation possibilities, recent years have seen an accelerating stream of Wall Street and the Square Mile's brightest and best leaving established investment firms and banks to join or start up hedge funds. A leading industry publication recently reported assets under management of the hedge fund industry totaled $1.34 trillion, nearly twice the total three years earlier. Some recent estimates have put the number of hedge funds in operation as high as 8,000. Once the preserve of the ultra-rich, hedge funds are now accessible even to the average investor through publicly listed hedge funds or funds of funds. What's more, all the major ratings agencies have recently indicated their intentions to develop or expand formal ratings for hedge funds.
Despite the high-profile activities of global macro funds such as Quantum and LTCM, hedge funds have generally been seen as shadowy organisations, and the industry as a whole has had a reputation for secrecy. This is largely borne out of their structure, operating through private placements and restricting share ownership to wealthy individuals and institutions. This frees them from most of the disclosure and regulation requirements that apply to institutions, mutual funds and banks.
Although many individual and institutional investors engage in a lot of the same activities as hedge funds, for many corporate executives hedge funds have become the new corporate raiders. Synonymous with aggressive short-termism and employing high pressure tactics, their interests are rarely seen to be aligned with the interests of any other stakeholder group. In calling for restrictions on hedge fund voting rights, one outspoken critic of the industry likened their power to allowing a wealthy tourist to buy the election of a country they are visiting for the weekend.
A broad range of financial strategies and instruments is at the disposal of hedge funds to persuade management teams of the seriousness of their intentions. This includes profiting from companies' anticipated weakness by shorting the stock and supercharging their bets by borrowing heavily to fund them - strategies not open to mutual funds and many other institutional investors.
The common prejudice is that hedge funds are 'hot money' with designs on a fast return and no concern for the consequences for companies or other shareholders. Naturally, this has affected how the management teams of public companies react to hedge fund managers. In 2004, Forbes magazine dubbed the industry 'The Sleaziest Show On Earth', claiming that "hedge funds exist in a lawless and risky realm". More recently, the New Statesman penned a lengthy piece entitled - 'Sell-out: Why hedge funds will destroy the world'. Such ongoing coverage has added to many management team's existing fears and reinforced the view that hedge fund engagement or interest necessitates an immediate call to arms.
| Some hedge fund managers are beginning to engage with the media as a tool to further their investment case and place the onus firmly on management teams to defend their position. | |
Some hedge fund managers are beginning to engage with the media as a tool to further their investment case and place the onus firmly on management teams to defend their position. However, few have taken the step of a formal programme of open outreach - conversations are far more likely to be 'off the record' briefings, further reinforcing the image of shadowy operators. A review of any newspaper on any given day will report on hedge fund and activist fund managers exerting pressure on management teams to deliver shareholder value - a recent example is that mentioned above where Centaurus in London and Paulson in the U.S. have banded together to force a break up of Dutch retailer Ahold. The reason - the new management team's perceived failure to deliver shareholder value quickly enough.
For many executives, the mere mention of a fund in Mayfair or Park Avenue showing undue interest in a company's stock would be enough to have them calling their advisors to start manning the barricades for the inevitable aggression and shorting action. But in reality, this type of action - unwillingness to engage with a potentially significant shareholder - may well be a self-fulfilling prophecy, leading a fund to an erroneous conclusion that the team has something to hide.
The hedge fund view is that they are simply looking for the investment strategy that will give their investors the best return. This is what they are judged on after all and investors enjoy the freedom to withdraw their money if they are not happy. Their aims may well be aligned with those of other shareholders. Despite being dismissed by Deutsche Borse chief executive Werner Siefert as opportunists that had no right to influence the firm's strategy, U.S.-based Atticus and London-based TCI successfully led a shareholder revolt to oust Seifert. TCI and Atticus were joined by a broad group of shareholders who were outraged at the management's failure to consult shareholders before announcing plans for its merger with the LSE. They also successfully forced the Borse's supervisory board chairman, Rolf Breuer, to resign.
More and more hedge funds are actively looking to research companies in-depth, meet with management teams and take a longer-term view on companies. Recent commentary in London's financial media has seen a number of CEOs suggesting that the hedge fund analysts are better informed and more useful to meet with than generalist fund managers.
| Hence the time has come for management teams and financial communications professionals to see hedge funds for what they have become - a group of smart potential investors with real clout that need direct, albeit careful engagement. | |
Hence the time has come for management teams and financial communications professionals to see hedge funds for what they have become - a group of smart potential investors with real clout that need direct, albeit careful engagement. As with any potential new investor, a level of due diligence is required to ascertain the likely agenda and investment goals and how these are aligned with a company's current prospects. Where appropriate, a financial communications agency or broker can act as a useful intermediary to conduct exploratory conversations, establish areas of interest and identify appropriate next steps, while also maintaining an open dialogue.
A leading hedge fund manager recently commented that "a good management team focused on delivering shareholder value has absolutely nothing to fear from us". Maintaining an open dialogue is the key and may produce a committed and supportive shareholder over the longer term. It is the responsibility of the management to ensure that it has a proactive stance towards its investors, hedge funds included, and it should usher them into the fold rather than shut them out in the cold without good reason. This means inviting them to presentations, being available for one-to-one meetings and using arenas other than the media to iron out differences. Traditional investor relations programmes can be as relevant for hedge funds as they are for other investors. Shutting out the hedge funds won't make them go away, but it may cause them to take another tool out of their belt - one that may be rather less favourable to management teams unwilling to engage.
Equally, hedge funds do themselves a disservice by maintaining silence in the face of the verbal onslaughts from the companies in which they invest. There is always a sound financial rationale for their behaviour, even where it might break from the traditions of the gentlemen's club in how it is approached. When there is no good reason for silence, they should disclose this rationale and remind the market why they do this - for the good of their investors. Given the increasing number of pension funds investing in the market, you and I are more and more likely to number among them.
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Ian Bailey, Managing Director and Alex Clelland, Account Director,
Weber Shandwick | Square Mile, Financial Communications
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