Hedge Funds: The Protean Survivalists E-Book

Russell Mutingwende

• Herausgeber: GRIN Verlag
• Kategorie: Fachliteratur
• Sprache: Englisch

Veröffentlichungsjahr: 2008

Beschreibung

Master's Thesis from the year 2006 in the subject Business economics - Law, grade: A- (German: Sehr Gut 1,5), University of Frankfurt (Main) (The Institute for Law and Finance), course: LL.M. (Finance), language: English, abstract: This paper investigates ‘activist investing’ as adopted by some institutional investors and hedge funds, and explores the resulting impact on the decision-making and corporate governance processes of the companies in which they invest. Firstly, it suggests that although activist investing has become something of a fad and its benefit to firm performance is still disputed, investors’ attitudes have changed and acceptance of the strategy is growing. Secondly, it posits that hedge funds, in keeping with their respective financial size and available resources will continue to apply this strategy with three key objectives in mind, namely: (i) To unlock value for short-term profit gains; (ii) To support a quasi-long-only medium-term (circa. 7 years) investment diversification strategy; (iii) To acquire businesses for the building of conglomerate industrial groups of companies, i.e. forging “King Cong” funds. For a more thorough introduction to hedge funds in general, readers are invited to read my earlier study titled:"The Challenge of reigning-in Hedge Funds through Regulation and the Need to improve Disclosure Requirements". the latter looks at: 1. Lack of transparency as a key feature of hedge fund investment 2. Benchmarking and Performance Measurement error 3. Risk management challenge presented by investing in hedge funds 4. Management Fees and their relation to performance and risk 5. Index funds & Fund of funds and their diversification advantages over hedge funds and other key topics

Leseprobe

Table of Content

Chapter

Chapter 1 Introduction.

1.1 Statement of problem.

1.2 Aims of the study.

1.3 Importance of the study.

1.4 Brief overview of the study.

Chapter 2 The history of hedge funds.

2.1 In the beginning

2.2 Definition of a hedge fund

2.4 Summary

Chapter 3 The evolution of the hedge fund industry

3.1 Investor profile

3.2 Hedge fund management and investment strategies.

3.3 Relationship with investment banks

3.4 Summary

Chapter 4 Shareholder activism and corporate governance issues.

4.1 History of shareholder activism.

4.2 Impact of hedge fund shareholder activism

4.2.1 The Deutsche Börse case

4.2.2 The McDonald’s case

4.2.3 The Medidep SA case

4.3.1 Corporate governance under siege.

4.3.2 Shareholder activism challenged

4.4 The future of shareholder activism for hedge funds.

4.5 The King Cong Funds

4.5.1 Eddie Lampert’s ESL.

4.5.2 Kennith Griffith’s Citadel

4.5.3 Stephen F. Feinberg’s Cerberus

4.5.4 Summary

Chapter 5 Conclusions and recommendations

Appendix A: Hedge fund definitions continued

Appendix B: 10 reasons to consider a virtual shareholder meeting.

Page 1

Page 2

ABSTRACT

The LTCM saga in the mid-90’s temporarily scared off institutional and private investors from investing in hedge funds. However, any trepidation was soon forgotten when the Dot-com bubble burst leading to an equities market crash in 2001. Subsequently, fund custodians sought additional portfolio diversification for their assets. Hedge funds had diversified their investment strategy-offering from predominantly long/short equity trading and global macros to include equity market neutral; event-driven; convertible arbitrage as well as fixed income arbitrage and managed futures. These combined strategies have assisted hedge funds in attracting more assets under management than at any time since their conception. Subsequently, there has been a growing involvement of large international investment banks in the establishment and the administration of hedge funds. Of concern (to some quarters) has been the ever increasing occurrence of shareholderactivism at board level, typically with hedge funds at the forefront.

This paper investigates ‘activist investing’ as adopted by some institutional investors and hedge funds, and explores the resulting impact on the decisionmaking and corporate governance processes of the companies in which they invest. Firstly, it suggests that although activist investing has become something of a fad and its benefit to firm performance is still disputed, investors’ attitudes have changed and acceptance of the strategy is growing. Secondly, it posits that hedge funds, in keeping with their respective financial size and available resources will continue to apply this strategy with three key objectives in mind, namely: (i) To unlock value for short-term profit gains; (ii) To support a quasi-long-only mediumterm (circa. 7 years) investment diversification strategy; (iii) To acquire businesses for the building of conglomerate industrial groups of companies, i.e. forging “King Cong” funds.

Page 4

Foreword

The term ‘Protean Survivalists’ in the title refers to Proteus1, a mythical god in Homer’s ‘The Iliad’. Proteus is depicted as a god who lives at the bottom of the sea and possesses the ability to prophesy. Proteus is adamantly reluctant to share his gift and defends his right to silence by using his other supernatural abilities to change his shape and form in order to discourage would-be pursuers. It is however said that whoever can constrain Proteus through his shape and form-changing episodes is eventually rewarded with a true prophecy. In their brief history, hedge funds appear to have developed the ability to change shape and form; whether they also have the ability to reward with true prophesies remains to be seen.

1"Some have the gift to change and change again in many forms, like Proteus, creature of the

encircling seas, who sometimes seemed a lad, sometimes a lion, sometimes a snake men feared to

touch, sometimes a charging boar, or else a sharp-horned bull; often he was a stone, often a tree, or

feigning flowing water seemed a river or water’s opposite a flame of fire.” - Ovid, Metamorphoses

8.731

Page 6

Chapter 1 Introduction

In 2005, assets managed by hedge funds globally exceeded the $1 trillion dollar mark (i.e. $1,000 billion) for the first time in their history. Although this still falls a long way short of the $ 25-plus trillion that is currently estimated to be invested in mutual funds, pension funds and insurance companies, it however endorses the industry’s growing influence in the global financial market space in terms of physical presence and buying power.

Thus, it seems surprisingly that only a decade ago, hedge funds were fighting for their existence following the now well-chronicled near collapse of Long Term Capital Management (LTCM), a hedge fund which promised - and for a short-while achieved - to earn returns that were up to 40% per annum. The active involvement and management of the fund by no less than two Nobel laureates and other academic and financial market luminaries made the prospect of consistently attaining returns far in excess of the market index an almost tangible and persistent reality. The financial practice known as leverage refers to the process of investing with borrowed money as a means of amplifying potential gains. LTCM’s excessive use of leverage in conjunction with other factors such as the lack of transparency in the industry, negligible knowledge of total credit risk exposure by the creditors of LTCM resulting from limited information-sharing, as well as the attraction of investing in a fund managed by proven brilliant academic and financial luminaries all contributed to the systemic risk exposure that LTCM presented until the US Federal Reserve-led consortium eventually stepped in to finance a rescue plan.

Gregoriou and Rouah (2003)2, aptly noted that the current problem with hedge funds is that there is a dearth of academic literature available defining their operations as “most of the literature and analysis of hedge funds has focused on assessing their performance”. Significant volumes of academic literature investigating hedge fund performance now exists and includes research by Argarwal, Naik, Brown, Goetzmann, Fung, Hsieh, Schneeweis and others. The first hedge fund, accredited to Alfred Winslow Jones, was a straightforward long/short structure, making its classification fairly easy.

2Gregoriou, Greg. N. & Rouah, Fabrice. 2003. Hedge Funds: The Steel Wave. Journal of Pensions

Management. 9 (1), p 22-33.

Page 7

‘Going long’ or ‘going short’ on a stock had been around long before Mr Jones; his genius was merely in putting the two together in a single structure, a concept which today may sound as easy as turning on a light-bulb.

Hedge funds have become more diversified in their investment strategies since then and therefore accurate classification is now a much more challenging prospect. The term hedge fund is often commonly, but erroneously, used to define the entire class of alternative investment vehicles. The increasing visibility and presence of other alternative investment vehicles such as private equity and venture capitalism has gone a long way to rectifying this misconception although hedge funds remain the most pre-eminent. This is due both to the amounts of money they continue to attract and to the headline-grabbing media reports that seem to follow their every move.

Notwithstanding the trillion-plus dollars entrusted to them, hedge funds continue to be mistrusted and in some quarters, openly disliked. A 2004 master’s thesis study of the hedge fund industry in South Africa by Mutingwende (2005)3highlighted that despite continued allegations of lacking transparency to the greater detriment of investors specifically, and the financial markets in general, most of the hedge fund operators surveyed were in fact strongly in favour of improving disclosure standards as they recognised the opportunity to mitigate the stigma of being high risk investments and to attract more capital as a result of improved transparency and clearer communication to investors.

The commonly-held view used to be that research on hedge funds and their activities was being inhibited due to the lack of disclosure by the hedge fund industry participants themselves4(Murguia, 2004). Another finding from the study (Mutingwende, 2005) was that the hedge fund managers still maintained that the challenge of providing relevant information timeously to investors had to be managed in conjunction with the threats presented by copycat funds as well as other market participants.

3Mutingwende, Russell. 2005. The Challenge of Reigning-in Hedge Funds through Regulation and

the Need to Improve Disclosure Requirements. Unpublished Thesis; Master of Commerce (Business

Management) Stellenbosch University.

4Murguia, Alejandro. 2004. An Alternative Look at Hedge Funds. Journal of Financial Planning,

(Vol.1): 42-49. January 2004.

Page 8

1.1 Statement of problem

In the 1980’s and 1990’s, hedge funds were generally following global macros, equity long/short and event-driven investment strategies. Unsurprisingly, most of the hedge fund operations were established by investment bank traders and corporate financiers who left the ambit of the larger investment houses to seek new business challenges and possibly the prospect of being able to determine their own bonuses.

As hedge funds diversified their investment strategies and attracted more assets under management, the hedge fund operators were faced with managing significantly larger volumes in their middle and back-office operations. Outsourcing was identified as the most viable and sustainable solution, and for a negotiated fee, the large investment banks that already had the personnel and systems in place were willing and prepared to take-on the additional administration functions. Out of necessity, the relationship between hedge funds and large investment was born and hedge funds had further endorsed their credentials as financial market survivalists. Faced with the risk of missing out on a viable investment prospect and the risk of losing highly-rated employees to competitors - and more importantly the cash-flush investors that such high profile employees typically attract, investment banks then seized the initiative by offering to provide seed capital to establish hedge funds for their most prized former employees. This paper questions and investigates the nature of the relationship between the hedge funds and large investment banks.