COMMENT
Hedge Funds Exposed

By David Kuo (TMFDragon)
December 9, 2004

If you are intrigued by hedge funds, and want to know how these investment vehicles seem to make money from thin air, then the following four books are worth putting on your reading list this Christmas.

"Hedge Funds: The Courtesan of Capitalism" by Peter Temple is a good initiation to the baffling and mysterious world of hedge funds. In this book, readers are introduced to Alfred Winslow Jones, the man who is credited with establishing the first-ever hedge fund in 1949.

Jones, a Harvard graduate, was fascinated by stock market risk. Additionally, his aim was to try and eliminate market risk by buying undervalued shares and selling overvalued ones. Jones also used borrowings to vastly improve the returns on his fund.

Despite the obvious success of Jones' investing model, Peter Temple does not attempt to hide his patent disapproval of hedge funds. He is particularly scathing about managers who borrow money and then invest in whatever they like. He compares these well-rewarded managers to gamblers who see the world as their casino, and use currencies, shares and commodities as their gambling chips.

"Inventing Money: The story of Long-Term Capital Management And The Legends Behind It" by Nick Dunbar takes a critical look at what can happen when a hedge fund, such as LTCM, goes bad. LTCM, which was founded by bond trader John Meriwether, was once labelled as a hedge fund that was too smart to fail.

LTCM, which was worth a staggering $130b at its peak, used complex mathematics and sophisticated computers to spot wrongly-priced options. However, LTCM collapsed spectacularly when it was found that two basic assumptions used in its modelling processes were badly flawed. LTCM incorrectly assumed that assets could always be sold at a reasonable price, and that mis-priced assets will always be corrected.

"Julian Robertson: A Tiger In The Land Of Bulls And Bears" by Daniel Strachman is a biography of one of the hedge fund industry's most successful managers. This book is peppered with insightful interviews with Robertson and his colleagues that provide interesting clues to the make-up of a successful hedge fund manager.

Readers will discover how Robertson almost single-handedly grew his Tiger Fund, which was worth just $8m in 1980, into an investment vehicle valued at more than $20b two decades later. The book also looks into the reasons for Tiger Fund's downfall, and the subsequent emergence of Robertson's protégés as successful Tiger Cubs.

Finally, "No Bull: My Life In And Out Of Markets" by Michael Steinhardt is my favourite book about hedge funds. Like Robertson, Steinhardt is legendary in the hedge fund arena, and this autobiography reveals some of Steinhardt's investing strategies that drove his success.

Steinhardt's book is rich in anecdotes that tug gently on the reader's heartstrings. They include, for example, how his interest in the stock market was sparked by a simple gift of shares from his estranged father for his Bar Mitzvah. Steinhardt also explains the importance of scepticism, which he refers to as "variant perception". But you'll have to read the book yourself to find out more.

> Buy these books at the Fool Bookshop.