Can hedge funds ever be ethical?

Written by Rebecca Jones on 24th Jan 2019

For many, the phrase ‘hedge fund’ invokes Hollywood images of rich white men in pinstripes sipping champagne in million-dollar penthouses as they bank profits from another day’s ruthless stock market trading (lunch, as we all know, is for wimps).

Others might, perhaps, think of George Soros and the successful $10 billion bet his Quantum Fund (the first ever ‘hedgie’), placed on the downfall of the pound on Black Wednesday in 1992; a move that cost the Treasury – and hence the UK taxpayer – around £3.3 billion and won him the infamous title of “the man who broke the Bank of England.”

Indeed, both the enormous fortunes amassed by hedge fund managers and the market moving trades they make are headline grabbing affairs – and very rarely are these headlines favourable.

 

Hedgies make trading go round

Some believe this is not entirely deserved. Joel Block, director of US based hedge-fund manager Bullseye Capital, argues that in-fact hedgies serve an essential function within financial markets.

He says: “Markets are filled with irregularities: sometimes they are a little overpriced, sometimes a little underpriced. […] If it gets a little too high there are people that force it lower, if it gets a little too low there are people that force it higher. If the stock is too high there are people that will short it to bring it down.

Hedge funds don’t lead markets; they correct them

“The role of some hedge funds is they are capitalising on aberrations or irregularities. They are doing exactly what the market needs them to do; whether people like them or not. Hedge funds don’t tend to lead markets; they correct them.”

Dejan Ilijevski, president at Sabela Capital Markets, adds that the huge amount of money hedge funds pump into the markets – particularly currency markets – also provides much needed pools of cash that keep the wheels of trade well-greased.

He says: “The markets are simply information-processing machines, quickly incorporating all available news and expectations.

“When hedge funds make bets in the short term, they still provide liquidity to other participants (even to those of us who think investing should be for the long haul) and, by pushing their expectations into the markets, hedge funds may even contribute to the overall fairness of security prices.”

 

Market movers

For those not entirely clear on what hedge funds do (i.e. most of us), they are complex financial instruments that place bets on the rise and/or fall of stock prices, currencies and commodities. Their aim is to preserve and grow investors capital under all market conditions.

This is, perhaps, a noble aim. However, as Black Wednesday showed, hedge funds can exacerbate the conditions of a currency or stock price crash, while some may even prompt tumbles if their large bets are publicly disclosed. As such, they are not always merely following markets, but moving them.

This line is often blurred, and difficult to determine. As an example, in 2016 a group of hedge funds helped to pummel the pound following the UK’s decision to leave the EU after it obtained information from private pollsters on the referendum result.

One hedge fund paid $1 million for a private poll that suggested the true result of the [EU] referendum

According to a Bloomberg report, one unnamed hedge fund paid $1 million for a private poll from You Gov that suggested the true result of the referendum. Accordingly, it placed large bets on a fall. Notably, this is all above board and legal, as long as the privately obtained information isn’t released.

On the eve of the vote, though, ex-investment banker and then leader of UKIP Nigel Farage – who happens to be best mates with a top private pollster – publicly conceded defeat, sending the pound sky rocketing ahead of the crash; eventually boosting profits for many short sellers.

The report has prompted MP’s to call in the Financial Conduct Authority to investigate whether private vote polling data should legally be made available to investors ahead of the public.

 

Brexiteers banking on a crash

Hedge funds have come under further fire recently for seizing on Brexit-related turmoil to place large bets on the downfall of British retailers including Debenhams, Marks and Spencer, B&Q and Intu, owner of The Trafford Centre in Greater Manchester.

Those banking on tumbles include prominent Brexiteers Crispin Odey, co-owner of Odey Asset Management, and Sir Paul Marshall of Marshall Wace, who donated £100,000 to the vote leave campaign.

According to a December Guardian report, Marshall currently holds £1.4 billion of short positions in British firms while Odey is hoping to boost the £220 million he made ‘overnight’ on the decline of the pound in 2016 with further short positions against the US dollar.

While unable to comment on the specific cases outlined above, Block concedes that the actions of hedge funds may be not always be ‘nice’. Nonetheless he insists they are neither immoral, nor unethical:

[Hedge funds] don’t always do what’s in the community’s best interest

He says: “It’s definitely unfair, and there are some not good people. However, if they are decent operators it’s unfair – but it’s not improper.

“[Hedge funds] don’t always do what’s nice; they don’t always do what’s in the community’s best interest, I would call them sometimes selfish. But is it improper or unethical? No. They operate legally; they just don’t play nicely.

“[In the 1990’s] George Soros did was what in his interest. It didn’t work out too good for other people, but he saw an opportunity and he took it. And that’s what happens.”

A Good idea gone wrong

However, chief executive of the Finance Innovation Lab Anna Laycock is a little more sceptical, adding that – fundamentally, we ought to question the ethics of anything that is trying to make money from an economy without supporting it.

She says: “Some hedge funds can have significant negative impacts on the real economy – for example, driving up the cost of essential goods including food and medicine.

“This isn’t to say that the basic concept of hedging – i.e. limiting your exposure to risk – is unethical in itself, but as is common in the history of finance, something originally developed to serve a useful economic or social purpose has lost that sense of purpose and instead become focused on speculative, short-term profit.

“Financial services should be just that: services which support a thriving, sustainable economy, not mechanisms to extract value and serve only a few.”

Perhaps, then, it is up to the individual investor to decide. If legality is the chief concern then hedge funds should be just fine. If, however, you define ethical as not causing and/or profiting from situations that have negative financial consequences for people less fortunate than yourself, you might have an issue.

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