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— Few things are more repugnant than wannabe alpha males. They're like high school boys snapping locker-room towels at each other. In the financial world, hedge funds are the youthful towel snappers -- barking and boasting and strutting, but wilting under pressure.

Talk to a hedge fund tout and you'll soon hear the word "alpha." It's supposedly the loot that a money manager rakes in by being smarter than others. "Beta," on the other hand, is the money brought in because the overall market is going up. The hedge fund wannabe alphas, aglitter with mathematics Ph.D.s, say their elaborate models can forecast the economy and the markets down to a gnat's eyelash. Alas, those lads haven't yet discovered that economics is not a science -- not even a dismal one. Neither economics nor investing lends itself to mathematical analysis.

The county's pension system brags that its "alpha engine," goosed by hedge funds, has led to a stellar performance. The portfolio has 20 percent of its assets in hedge funds that primarily specialize in so-called alternative investments -- not the stodgy old stocks, bonds, cash, and real estate, but exotic "derivatives" and "synthetic" investments, ad nauseam.

A derivative is a financial instrument whose value is derived from some security, such as a bond or a stock. There are two types: options, or the right to buy or sell something in the future, and forwards ("futures" if traded on an organized exchange), which are obligations to buy and sell in the future. Derivatives are combinations of options and forwards, and the degree-spangled Ph.D.s stir the pot frenetically, coming up with crazily complex derivatives. In the 1990s, Orange County went broke buying derivatives it didn't understand. Despite that disaster, the San Diego County pension fund began going into derivatives in the 1990s and by late in the decade was dabbling in them through hedge funds (which, incidentally, Orange County won't touch today).

On July 21 of last year, the board of the San Diego County Employees Retirement Association diversified its hedge fund activities further by adding two "multi-strategy" hotshots: Amaranth Advisors and D.E. Shaw and Co.

Amaranth is a flower that stays fresh for a long time after it's picked. To poets, it's a symbol of immortality and incorruptibility. But Amaranth Advisors managed to lose $6.5 billion of its $9 billion last month and plans to shut down. A young trader made bad bets in natural gas futures contracts, while the fund's risk-management staff let two-thirds of the capital veer down a one-way street. It's typical of hedge fund cockiness and typical of the ignorance of those who put their money in such highly secretive, unregulated pools. The San Diego County fund had $175 million in Amaranth's pot. It will lose most if not all of that.

The County rushed to explain that its Amaranth investment was a small piece of the pie, and the total fund made a 15.6 percent return in the year ended June 30 -- well above the 8.25 percent it expects to make each year. That sounded like the City in 2002 claiming all was well with its pension fund.

Staff members of the county pension system say that the Amaranth debacle is an aberration, but all along, San Diego County treasurer Dan McAllister, a boardmember, has been skeptical of the outsize commitment to hedge funds. "I think it's important that we reassess our risk-tolerance levels -- that we revisit these hedge fund investments," says McAllister.

"This position has not been expressed by the board," says Brian P. White, chief executive of the county pension system.

Just recently, the pension fund's actuary recommended that the annual target be reduced from 8.25 percent to 8 percent. McAllister favored this conservative move. He was voted down. Chief investment officer David Deutsch, with alpha-male swagger, boasted, "If any plan ever qualified to add expected excess return to an interest rate assumption, it would be San Diego. The investment program has earned excess returns over the past ten years of 1.0 to 2.0 percent. There is a 90 percent chance that these returns are due to skill, not chance." (Italics mine.)

At San Diego cocktail parties, people are mentioning hedge funds in the same breath as J. David Dominelli, who promised 40 to 50 percent annual returns during the 1980s but was discovered to be running a Ponzi scheme, a swindle in which early investors are paid off with funds coming in from new investors. It collapses when new investors dry up.

Could some hedge funds paying fat initial returns be Ponzi schemes? Maybe. Who knows? Most are based on offshore secrecy havens.

As hedge funds proliferate, their annual returns are coming down, and two economists have calculated that over the long term, hedge funds underperform the Standard and Poor's 500, a broad blue-chip stock index.

So why do people plunk their money in? Two reasons: cupidity and stupidity. Throughout history, when investment categories get hot, too many fast-buck artists have rushed in and too much money has been thrown at them. Hedge funds were small factors in the early 1990s. Then promoters noticed that hedge fund managers charged 2 percent of total assets plus 20 percent or more of profits. A sure way to riches. Well-heeled investors liked the then-high returns, the secrecy and offshore locations. Now, there are 7000 to 9000 hedge funds (no one is sure) with well over $1 trillion under management, and shady consultants tell wannabe alphas how to do such things as rig their track records to make it appear that they are big winners.

At first, hedge fund alphas claimed they did so well because they were besting the indolent old-style managers. That was a dubious argument. Now hedge funds have multiplied so rapidly that they are fleecing each other. Consider Amaranth. It was betting that the difference between March and April natural gas futures prices would widen. March prices would rise and April prices fall, believed Amaranth -- normally, a good bet. Not this time. The spread contracted precipitously. Speculators on the other side of the contracts saw that Amaranth -- like all hedge funds, heavily in debt -- was in trouble. So those betting against Amaranth redoubled their bets, knowing that a swaggering alpha was now staggering.

Playing with hedge funds and derivatives is a wicked game not suitable for pension funds. "If wealthy individuals want to roll the dice, it's up to them," says former San Diegan Gary Aguirre, who was investigating a hedge fund for the Securities and Exchange Commission when he got fired for taking his job too seriously. "But university endowment funds and pension funds? Their role is not to play Las Vegas."

The county pension system has money in 11 hedge funds. D.E. Shaw, run by a former computer professor, specializes in quantitative strategies. It got in trouble in 1998 after the Russian default but seems to have righted the ship. Silver Point Capital specializes in high-risk lending. Berens Capital Management is a fund made up of other funds focusing on emerging markets. Rancho Santa Fe's Freeman Associates goes both long (betting stocks go up) and short (betting they go down). In its last annual report, the county pension fund made little mention of risk, noting obliquely that there might be a "possibility that future changes in market prices may make such financial instruments less valuable." White says the 2006 report "will be changed."

Pat Shea, who was a primary lawyer in the Orange County bankruptcy and ran unsuccessfully for San Diego mayor, says that in the public sector, "We have created an incentive for risky investments. The public is required to backfill all the money lost. If I bet on a risky investment and it comes in a winner, I pull out the money (above the target 8.25 percent) and spend it on other stuff. But if I bet and lose my shirt, I turn the bill over to taxpayers, who have to put the money back.

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