Still Risky After All These Years
Hedge funds are nothing if not controversial. In September, Amaranth Advisors made the front page of the Wall Street Journal for days on end by losing an astonishing $6 billion in a single week on bad trades and failed investments. The rapidity of the fund’s collapse highlighted potential risks for investors and prompted a new wave of criticism of the secretive hedge fund industry, which now has over $1 trillion under management. A few weeks after the Amaranth debacle, the Economist led with a cover story warning that “private lenders, such as hedge funds, are extending vast amounts of credit to leveraged buy-out firms and other private borrowers. Forsaking the sunlit uplands of global finance, the market for capital is plunging into the shadows. . . . In thinly traded, lightly regulated and untransparent markets, the bold can make an awful lot of money—and they can lose it on an even more extravagant scale.”
Amaranth’s crash brought back memories of hedge fund mogul George Soros’ cornering of the market on the British pound in the 1990s, and the $3.6 billion collapse in 1998 of Long-Term Capital Management, a hedge fund run by Nobel economists and Wall Street insiders that failed after its over-leveraged bets went sour. For an otherwise unconcerned public, hedge funds gradually became synonymous by the late 1990s with secrecy, arrogance, and hubris. With the news about Amaranth, critics are again arguing—as they did nearly a decade ago—that hedge funds need more regulation and oversight.
But the recent tribulations don’t raise alarm bells for those who manage the college’s endowment, says Reed investment analyst Andrew Lonergan, and they don’t indicate that wholesale changes to the investment strategy are warranted. Lonergan, a Portland native, came to Reed last year after stints at Windermere Investment Associates and Credit Suisse Asset Management.
Lonergan says that Reed has historically invested prudently in hedge funds, and hasn’t used funds that employ a lot of leverage, or borrowed money, to pump up their profits. And while it is true that Reed’s hedge fund allocation—at around 40 percent—is high for college endowments of comparable size, Lonergan says the mix of funds that Reed owns is safe and stable. “People might hear that Reed invests in hedge funds and start thinking of Amaranth, and conclude that all hedge funds are risky and Reed shouldn’t be using them,” Lonergan explains. “People have this idea that if you only invest 20 percent of the endowment in hedge funds, you’re taking less risk than if you invest 40 percent in hedge funds. The reality is that we could be 100 percent invested with hedge funds and have much less risk than an institution that is 100 percent invested in long-only stock mutual funds.”
As of this autumn, the college was invested in six small, nimble hedge funds, most of which base their investments around stocks, rather than the sorts of complex financial strategies that have put a few notorious hedge funds in the crosshairs of public opinion. Two of Reed’s funds use a strategy that is virtually indistinguishable from a conventional mutual fund—investing in stocks that the fund manager believes will rise in value. The difference, Lonergan says, is only in the legal structure of how the money is managed. “It’s gotten so that ‘hedge fund’ is a term that almost doesn’t mean anything anymore,” he says.
Many industry insiders contend that tarring hedge funds with a broad, critical brush misses the point of most of these investment vehicles, which quietly go about their business of delivering consistent returns and insulating investors from big slides in the stock market. So says Chris Wolf ’77, co-founder of Cogo Wolf Partners, an investment firm in San Francisco with $70 million under management. Wolf, who makes his living picking out other hedge funds in which to place his investors’ money, says people outside the finance industry don’t give much thought to small, specialized hedge funds that continue to deliver enviable returns to investors such as Reed, and have done so with little tumult for the past three decades.
“There are anywhere from 8,000 to 9,000 hedge funds out there,” Wolf says. “If you hear about five a year that are blowing up, that’s a small number.” He says that funds made up of other hedge funds—the type he manages—are even less prone to trouble.
Portland hedge fund manager Yusaf Jawed ’91 of Grifphon Asset Management has been following Reed’s investment strategy from the sidelines, and says it makes good sense to him. “Reed invests in a variety of hedge funds,” says Jawed, whose firm has about $50 million under management—small by industry standards. “Think of it as 10 stocks—one may be down but the others will keep up your returns. Most of that kind of success comes from knowing the philosophy of your managers. Bad things happen in the markets. That’s why you need to diversify and not have all your money in one hedge fund, just the way you wouldn’t have all your money in one stock.”