It is a fascinating phenomenon in the financial sector. It is a world where people put an enormous amount of intelligence, knowledge, and experience to work to improve the returns from capital investments by a couple of percentage points or even only a fraction of a percentage point. Managers think profound thoughts about economic relationships, analyze political shifts in far-off countries, build up data banks, work out algorithms, and send self-learning software off into the running. All of it only to financially position themselves and their investors a little bit better.
This phenomenon can be seen not only at hedge funds, but also at investment banks, conventional asset managers, high-frequency traders, and investment companies. It also isn’t seen at all hedge funds – this sector knows a lot of average people and losers along with the geniuses. But hedge funds today more or less symbolically represent the effort to make more money out of money by all means available. In the industry, sometimes individual managers earn billions in a single year.
Donald Trump speaks a lot of nonsense in the U.S. election campaign. But his accusation that hedge funds are only “shifting paper around” hits a nerve. Because the question arises, does the world need this kind of undertaking? What is the sense in what hedge funds do? Without the car industry, nobody could drive a car, without restaurants nobody could go out for a meal, without ATMs, nobody could withdraw cash around the clock.
Do the huge sums of the derivatives businesses in the books of banks that worry financial regulators so much have any benefit to the economy?
But would the world really be poorer in the eyes of investors, meaning the customers, without hedge funds? Hardly likely.
There is no question that a well-functioning capital market is enormously important for the economy. How important is always seen again when these markets cease to function, as in a financial crisis. It is also no question that rational decisions by investors contribute to capital not being wasted but instead being put to good use. So part of the thinking for the intellectual justification of complicated products and structures on the financial markets is that they contribute to the optimization of the use of capital. But how far does this opitimization need to go?
Forward and future contracts to ensure against risks, the hedging, have been around for centuries. When a farmer sells his harvest in advance to a taker, it is a forward contract that provides security for both the buyer and the seller against price fluctuations. There have also been stocks and interest-bearing securities for centuries. What would be lost if we had to make do with these relatively simple products today? Would investment, or the use of capital, really be less effective? Wouldn’t investors be in a position to shape their investments according to their own needs? Wouldn’t that cover the risks? Or would the risks only be better hidden in today’s more complicated structures? Do the huge sums of the derivatives businesses in the books of banks that worry financial regulators so much have any benefit to the economy?
Most of these questions can be safely answered with no. The capital market would function even without the use of highly-complicated instruments. Hedge funds and other similar highly-overbred undertakings mostly suck money out of the capital market of other, less cunning investors and distribute it to their own investors. When their customers are something like pension funds or insurers, not much damage is done by it since the money is largely distributed back to the same group of investors from whom it came.
But hedge funds often also work for rich private customers. Moreover, the hedge fund managers siphon off a good share for themselves and pay their employees fat salaries. All of that is contributing to the unequal distribution of wealth, particularly in the United States – a phenomenon that is now being seen in America not only as a social problem but also as an economic one. Billions in wages for individual persons offend the sense of justice and thus undermine the cohesion of society.
But the even more crucial question is why is so much intelligence and talent being wasted on such a dubious purpose? Why, when there are so much more meaningful pursuits, more meaningful even for the persons themselves.
We can’t and shouldn’t forbid everything in a liberal society that is of no real benefit. But financial acrobats also don’t have to benefit tax-wise and in terms of supervision. And we can save our admiration for other talents and skills.
The author is a correspondent in New York. He can be reached at [email protected]