Tuesday, April 08, 2008

Hedge Fund Manager

Nice interview of a hedge fund manager. He's not sure what the recent turmoil will mean for the industry overall:
The investors pay pretty rich fees to invest in a hedge fund. Often it’s 2% per year, and 20% of the profits—which is why it’s great to be an HFM.

But to justify those fees you have to give people something they can’t get from more cost-effective investment vehicles. What hedge funds claimed to be providing was returns that weren’t correlated to major market indices, returns that were superior to what you could get in other asset classes, and that you’re getting the best talent and risk management and superior returns with lower risks. What we’re seeing this year is that it’s becoming a very risky asset class very quickly, and that it became an asset class with a high degree of correlation among funds.
Much of the money pouring into hedge funds these days are from pensions funds and sovereign wealth funds, tired of lousy rates on treasuries. A friend of mine, who is much closer to all of this than I am, thinks this will end badly for them. He says that they're simply paying a lot of money to hold equities.

This point about the fundamental link between bad financial prices, and bad real investment decisions is critical, and lost on people like DeLong who just look at (near term) aggregate employment.
In the situation we have today, where people have made bad investment decisions, where people built houses they never should have built, there’s a misallocation of resources. The loss has already happened. The loss isn’t what happens on a balance sheet: the loss is what happens when someone cuts down a tree, makes cement, builds a 6,000-square-foot house in a place it should never be built. So the loss has already happened. The question is: How do you allocate that loss? And if you don’t allocate the loss, if you pretend it isn’t there, then this has really baleful consequences for the economy. So what we’re going through now is this process of loss allocation. It can be done swiftly, fairly, and intelligently, or it can be done slowly and messily, and inefficiently, and also it can be not done at all
An awful lot of political noise is being made about doing whatever it takes to keep people in houses they cannot afford, in locations they do not like.

This point about the destruction of real wealth that accompanies investment booms echoes points Steve Waldman has been making for a while, but here's his latest post on the subject:
Private, profit-seeking actors would not have generated the corrosive financial flows that have characterized this millennium. "Financial imbalance", a euphemism for real resource misallocation, would have quickly been corrected, had Wall Street and the City of London not learned that the official sector could be their best customer.
But how wisely can resources be allocated in a monetary environment where savings are forced into investment/consumption through endless cycles of dilution. The US$ has lost over 90% of its value in the last 100 years. It's done phenomenally well economically. Does this make any sense?


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