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Hedge funds raise stakes on Street

By ROBERT TRIGAUX
Published May 27, 2005

Wall Street may appear to be 2,562 long miles from Las Vegas. The truth is the capitals of investing and gambling have drawn closer and now are within hailing distance.

The rapid rise and spread of 8,000-plus hedge funds - leveraged, tight-lipped and little-regulated investment funds for big institutions and wealthy individuals - are helping to close the remaining gap between The Street and The Strip.

I'm not sure we've noticed, but our appetite for financial risk is growing.

The difference between speculative investing for high returns and Vegas betting for big payoffs is starting to blur. Both approaches to making money are gaining popularity.

Investing in yet-to-be-built Florida condos and buying lottery tickets are close runners-up. And spinning off a piece of Social Security to invest in the markets, a top priority of the White House, may not be far behind.

If this column ran in the tabloid New York Post, the headline might read Invasion of the Hedge Funds! And it would be correct. Hedge funds that once engaged in specialized investments in derivatives and other exotic financial instruments are entering mainstream America, pushing aside more traditional investment firms and grabbing stakes in publicly traded companies.

In the Tampa Bay market, the hedge fund invasion was brought to light Thursday in St. Petersburg Times business reporter Scott Barancik's story about a hedge fund, appropriately named Pirate Capital, that has invested in Tampa's Walter Industries.

The Connecticut-based hedge fund told Walter it is worth more to shareholders if the company is broken into three parts. Pirate, Walter's No. 3 shareholder, threatened a proxy fight if Walter did not comply. The company is considering its options.

You can almost hear the Arrgh! in Pirate Capital's demand.

Thousands of hedge funds are blossoming because investors with money want higher returns they can't get from the waffling stock market or from banks or bonds. But that demand for bigger paybacks comes at a price: higher risk.

Hedge funds once content to deliver hefty 10 percent returns to investors have turned far more aggressive and increasingly leveraged - borrowed more money - to promise 20 percent returns, says John Makin, a visiting scholar at the American Enterprise Institute think tank in Washington. The problem is such returns require hedge funds to invest in riskier assets, stuff that is tougher to convert quickly to cash. Especially when interest rates are starting to rise.

If investors lose confidence in their hedge funds and cash out, the funds could become strapped for cash. It's called a liquidity crisis. When it happens to banks, it's called a run on deposits.

It's happened before.

In 1998, a well-regarded hedge fund called Long Term Capital Management could not meet its investors' demand for cash, causing a global liquidity crisis that prompted a bailout by the Federal Reserve. More recently, problems at George Soros' Quantum Fund and the dissolution of another legendary hedge fund, Julian Robertson's Tiger Fund, raised questions about the little-known hedge fund industry.

Fans of hedge funds point out that the vehicles are for sophisticated investors who should know the potential perils.

Since Long Term Capital's fumble seven years ago, the hedge fund industry has grown to $1-trillion in assets, or three times larger.

But the push to invest in and influence public companies puts hedge funds in lesser-known territory. Two prominent investors in the recently announced merger of US Airways and America West are hedge funds.

Last month, hedge funds turned in their worst performance in more than two years. And rumors swirled this month that several hedge funds with large stakes in General Motors were in trouble after betting GM bonds would rise while its stock would fall. The opposite happened.

Globally, investors poured a net gain of $25-billion into hedge funds in the first quarter of this year. It's a reminder of today's insatiable appetite for higher returns and how little anybody really knows about where all that hedge fund money is going.

Even here in little ol' Tampa Bay.

Robert Trigaux can be reached at trigaux@sptimes.com or 727 893-8405.

[Last modified May 27, 2005, 00:39:13]