Growing up

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THE past few years have not been kind to the hedge-fund industry. Many funds were scalded by the bond-market debacle in 1994; even more were badly burned—some fatally—by last years turmoil in the financial markets, when Long-Term Capital Management, one of the biggest, had to be rescued by its bankers. Those two events help to explain why hedge funds in general have done badly in recent years. A new hedge-fund index, launched this week by Tremont Advisers, a research firm, and Credit Suisse First Boston, shows just how badly. But the mere fact of its creation also points to an industry trying to spruce up its image.

More openness might help. Traditionally secretive to the point of paranoia, hedge funds are beginning to be less so. To be included in the index, hedge funds must have audited accounts and guarantee to provide monthly data. Astonishingly, nearly all of the top funds have agreed to do so. Even John Meriwether, who ran the super-secretive LTCM and is now trying to launch another hedge fund by the end of the year, has asked what he would need to do to have his fund included in the index.

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Openness should make the cost of financing positions less exorbitant than it has been. Scarred by LTCM. banks have become less willing to lend to hedge funds, which provide them with only minimal information about what they are up to. An analyst at one big investment bank reckons that, since August last year, the amount of finance it provides to hedge funds has fallen by 90%.

Another reason for greater openness is that hedge funds are trying to attract more money from institutional investors, not just the rich individuals who have been their traditional source. Institutions, they think, will take a longer-term view, and so not upset their trading strategies by pulling out their cash in bad times. But they will demand both better information and benchmarks to measure performance. In return, they will bring a certain respectability. Although the World Bank has invested its pension money in hedge funds for the past 20 years (and now invests some $50m in them), the California Public Employees Retirement System ( CALPERS ) caused a stir in August when it announced plans to invest some $2.5 billion in hedge funds and other alternative investments. Other institutions are, as a result, starting to sniff around.

Institutions may be loth to invest in a fund that is, in essence, a one-man show. That means that hedge funds need to hire more good traders—and keep them. Many successful ones leave to set up their own funds. The main way in which hedge funds are seeking to convince investors that they are not the creature of a single star trader is to hire top Wall Street types to run the business side. Tiger has poached Philip Duff, who was chief financial officer at Morgan Stanley Dean Witter; Mr Soros hired Duncan Hennes, an erstwhile treasurer at Bankers Trust; and Tudor Investments brought in John Macfarlane, a former treasurer of Salomon Smith Barney. “They are being brought in to turn what were personal fiefs into properly managed companies,” says a boss at one big investment bank. It is, says Nicola Meaden, who runs Tremont in Europe, almost inconceivable for any fund set up in the past two years not to have a business manager.

Perhaps funds should cut their fees too. Although a few have turned in stellar performances, not one of the nine index categories has outperformed the S&P in the past five years. Since these indices are net of fees and the fees are so high (typically a 1% management fee and 20% of all profits), reducing them would gee up their performance. As Byron Wien, a strategist at Morgan Stanley Dean Witter, scathingly told a recent conference: “Most hedge funds dont deliver the sort of performance to charge 20% fees. they are lucky there are so many dumb rich people out there”. Institutions, presumably, will be rather cannier.