David Tepper's gutsy performance last year was a throwback to what a lot of people still think most hedge fund managers do: Take swaggering bets that go against the grain, make billions and end up turning everyone else into a follower. How else to explain his willingness to buy Bank of America when the dreaded N (nationalization) word was still being bandied about? As our cover profile this month details, Tepper says he was merely taking note of the U.S. government's own promises and acting appropriately. But Tepper's investors had to brace themselves before everyone else caught on.
If understanding the government's moves is how to make money these days, one has to wonder if it is going to be another stomach-churning year. (Tepper's biggest worry, however, seems to be that it's going to be boring.) The result of the special U.S. Senate election in Massachusetts is raising more uncertainty, as the Obama administration tries to recapture the moral high ground by levying the banks and limiting their investments in hedge funds and other activities.
Repaying taxpayers and paring down the size of these too-big-to-fail institutions is a noble cause. But does peeling hedge funds away from banks make much sense? Under the plan, two of the biggest U.S. hedge fund businesses—Goldman Sachs Alternative Asset Management and JPMorgan's Alternative Asset Management (including Highbridge Capital Management)—might have to be spun off from their parents.
Even though it's huge, JPMorgan is one of the few banks to have figured out how to run a hedge fund business successfully. JP Morgan is a stickler on managing conflicts of interest, and one of its policies is to make the thing stand on its own—and not invest bank capital into it. Without bank support, Highbridge still staged a comeback last year, driven by the rally in convertibles.
Goldman took another route, pumping $3 billion into one of its flailing funds during the quant crisis of 2007. Now Goldman has shut down its Global Equity Opportunities Fund, which fell from $7 billion to $200 million. Perhaps being independent wouldn't hurt. At least when investors lose money, they won't be able to grouse that Goldman's prop desk keeps all the good trades for itself.
The administration's moves come at a time when hedge funds are being drawn into an insider trading scandal that has everyone in the industry on tenterhooks—the subject of our In Depth feature. The worry is that hedge funds will be as tarnished as junk bonds became after the Milken scandal in the 1980s.
As financial reform wends its way through Congress, it will be up to the industry to persuade lawmakers not to penalize alternative investments that—at the very least—might help put pension funds back in the black. Yet anything that smacks of privileged treatment for a tiny few at the top is likely to come under scrutiny. Making a few concessions might just be the best way to polish the industry's image.
