Complex and expensive they may be, but hedge funds can benefit us all

The Medallion fund run by US firm Renaissance Technology is discussed with reverential awe in hedge fund circles. It used to charge 5pc and 20pc. Then it increased the performance fee to 36pc, and then to 44pc. Then the fund was shut to new money. Many investors would happily sell their grannies into slavery to gain access. Why? Because the Medallion fund is one of the best around. Since it was launched in 1988 it has only lost money in one quarter, according to The Wall Street Journal.

There have been several years when the fund has returned more than 35pc – and that’s after fees were paid. Those high fees have made some hedge funds very big and some hedge fund managers very rich. Is that a problem?

Those who think it is should consider this. In 2011, the list of Britain’s biggest taxpayers was topped by a hedge fund manager: David Harding, the founder of Winton Capital. He paid £34m in tax on his income of £87m – enough, as one newspaper pointed out, to fund the salaries of 1,500 newly-qualified nurses.

Of course, many rich hedge fund managers are also notable philanthropists. Michael Hintze, founder of London-based CQS, has given money to more than 150 charities, ranging from the Trinity Hospice in south London to the restoration of the Pauline Chapel in the Vatican.

But the success of the hedge funds is about more than the individuals – finance is now one of the UK’s main export industries employing many thousands of people and responsible for many billions of pounds flowing each year into the Treasury. Why are we not celebrating it more?

Beyond simple jealously there is a prevalent belief that hedge funds shoulder a portion of blame for the financial crisis. So let’s be clear: they had nothing to do with it.

The practice of short-selling has been used to demonise hedge funds. Selling shares in a company that you don’t really own in the hope that they will fall in value intuitively feels wrong. There are some, including those at the heads of the investment banks that went to the wall in 2008, who believe that short-selling forced companies out of business. That is not true. Look at the share price of banks in the lead-up to the crisis – they steadily fell right up to the point when certain governments banned short selling; then they collapsed.

Short-selling helps set the price of shares, especially in extreme market conditions. Remove it and the only means that investors have to express their view of an ill-favoured stock is to pull out completely.

In fact, from a financial stability point of view, wouldn’t we rather have lots of relatively small, diverse companies making different investments in different ways than a few Too Big To Fail behemoths lumbering around? Hedge funds aren’t as leveraged as banks, they aren’t as interconnected, and – absolutely crucially – they don’t need to be bailed out by taxpayers when they fail.

Of course, as in any industry, there is a significant minority of hedge funds that are badly run, that are not worth the high fees they charge and will end up losing investors money. They should be more open and better regulated; all of the arguments about fees, complexity and financial stability are open to debate. But there is an even more important reason why society should be encouraging and not discouraging hedge funds: old age.

Most of the world’s nations are facing a demographic timebomb. The near extinction of final salary pension schemes has left many people in the developed world with smaller nest eggs than their parents.

Hedge funds manage money for pension schemes, endowments and charities. By doing so, they are helping us to fund our increasingly long and increasingly impoverished old ages.

But even more important than that, the hedge fund industry acts like an enormous field experiment for investment strategies. Some fail. But those that succeed are refined, simplified, become cheaper and are adopted by others. What was investment avant-garde soon becomes mainstream. Just as high fashion looks outlandish but eventually influences what we all wear, so high finance looks ridiculously complex but will eventually shape what goes in all our ISAs.

We need to make today’s increasingly meagre savings pay for many more tomorrows. Personally, I’m happy that we have a few rocket scientists working on what could well be one of the biggest problems facing society over the coming decades. I’m surprised the Labour Party isn’t too.

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