Sebastian Mallaby, a veteran journalist who has worked for the Washington Post and the Economist, came out this summer with what has been described as the definitive study of the hedge fund industry with his book "More Money Than God."
Using his access to some of the most secretive and wealthy investors in the world, Mallaby explored the gilded world of these highfliers and explained why many hedge funds seemed to come out of the financial crisis better than the rest of the financial industry. A few big names like John Paulson raked in billions during the meltdown.
Hedge funds have been making headlines again of late. Last week federal agents arrested a consultant to a number of hedge funds, in what looks to be the beginning of a massive new investigation of insider trading. Don Chu, an executive at New York-based Primary Global Research, is accused of providing several hedge funds with early looks at unreleased information about publicly traded companies such as Broadcom Corp., an Irvine-based maker of microchips that are used in iPhones and other products.
The Times caught up with Mallaby to ask about the origins of the investigation and what it might mean for the future of this booming corner of the financial world. Here is an edited transcript:
Question: When your book came out did you have a premonition that anything like this investigation might be coming?
Answer: It doesn't surprise that, from time to time, when there is an insider-trading scandal, hedge funds will be mixed up in it.
You start from the idea that these guys are the most aggressive investors seeking any kind of edge they can get, any time. And then you've got an industry that uses expert network consultants that may be on the edge of legality.
It also doesn't surprise me that after a big financial crisis the prosecutors have had to collect some scalps — and they get more aggressive in the way they go after potential crooks.
Q: How new are these expert networks?
A: In the past successful investors constructed their own expert networks.
Take the example of Julian Robertson, who ran the Tiger Fund between 1980 and 2000, the core of which was stock-picking. He had two Rolodexes almost the size of wagon wheels. Whenever he was advised to take a position in a stock, he could usually pull out of those Rolodexes three names of people who had worked for the company in question or been a senior executive at one of its suppliers, and he would call them up and have them debate his analyst.
He was a master networker.
The new thing may be that, as the financial sector has grown and become more specialized, you have companies that style themselves as boutique expert network providers, whereas before, this was folded into the larger houses or the hedge funds would do it for themselves. But it's always been the case on Wall Street that who you knew was the currency.
Q: A number of the people whom investigators are tracking in this case have had some connection with one of the most famous hedge funds, SAC Capital, run by Steven Cohen. Why might Cohen and his firm be attracting the attention of prosecutors?
A: Steve Cohen has had among the highest returns in the industry.
Insiders in the business for a long time suspected that his special sources amounted to privileged information. The debate amongst insiders was, "Was the special information on the right side of legality or the wrong side?" But I think it was a pretty common view that it was close to the edge.
The returns were really very high and it wasn't as though there appeared to be some sort of special source that you could easily understand. For example, Renaissance Technologies makes extremely high returns as well, but everybody understands that there is an algorithmic trading strategy that is simply the best ever invented. This guy Jim Simon [the founder of Renaissance] brought together a team of outstanding mathematicians. They make extraordinary returns but we understand they are better at math than we are.
When you have somebody who doesn't appear to have that readily identifiable edge, who nonetheless makes much higher returns than other people, you wonder.
Any curious prosecutor looking at white-collar financial crime would know that and would have SAC as something to keep an eye on.
Q: You argue in your book that the benefits of hedge funds outweigh the risks. Why is that?
A: Even though hedge funds get mixed up in financial scandals, there is no evidence that they are systematically more prone to breaking the law than other types of investment vehicles.
