Mayfair's stealthiest profit-hunters begin to emerge from the shadows

City fears growing power of secretive industry

When New York-born investment banker Olivier Bonnefoy wanted a career change he decided to open Gentlemen's Tonic, a combination of old-fashioned barber shop and health spa where stressed-out men could go for a little pampering.

Hair is cut in smart private booths with their own televisions and wi-fi internet access. There are facials, massages and body waxing. He located the business where the wealthiest of his former colleagues are concentrated: not in the City of London but in Mayfair, the home of the hedge fund.

Around a third of his clients, he says, are "alternative" investment managers. Discretion here is of the utmost: the barbers are instructed only to hold conversations if the client wants one. The business was breaking even three months after opening last year, he says.

Gentlemen's Tonic is in a back street off Berkeley Square, not far from the restaurant Nobu, the private members' club Mortons, Claridge's hotel and dealerships for Bentley and Jaguar, all favourite haunts of the burgeoning breed of hedge fund managers. A decade ago there were no hedge funds in the area, Bonnefoy says. Today, if a man in his 30s drives past in a Ferrari, "you assume he's a hedge fund manager and nine times out of 10, he probably is".

Hedge funds are loosely defined as vehicles that invest money for the super-rich, and increasingly for other financial institutions, including pension funds. They have a prohibitively high minimum investment and, as their investors are supposed to be sophisticated, they are pretty much unregulated. They can use whatever investment strategy they want; some straightforward, others fiendishly complex. Most of the funds are domiciled off-shore in locations like the Cayman Islands or Bermuda for tax purposes.

The fund managers are chasing Alpha, the difference between the performance of the broad market and what the hedge fund manager is able to return. The industry is growing rapidly. At the last count there were between 8,000 and 10,000 hedge funds worldwide managing anywhere between $1 trillion (£534bn) and $1.5 trillion. A decade ago, the industry had just $260bn under management.


The shop gives Bonnefoy a unique insight into how the industry is performing. "We have cancellations when there are big movements in the markets ... people need to be behind their screens," he says. "Things have been a bit bumpy in the past six months and there are a few people we haven't seen in a while. You know they are out seeing clients, explaining the recent performance."

A short walk away in Lower Regent Street, another fund is launching. Carmel Daniele wants to raise $100m by the end of the month. It might sound ambitious but is peanuts in the high-octane world of the hedge fund. Daniele is a small, softly spoken Australian with thick black hair, dressed in a scarlet shirt beneath a businesslike grey suit. She sports a wide grin and earrings made from her initials, the C clasping her ear and the D dangling below. Hedge fund managers like to think of themselves as a little more rock'n'roll than their big bank brethren, and are as a rule a little more dress-down.

Her fund, CD Capital, focuses on investments in natural resources such as copper, zinc, oil and coal. The business model is not dissimilar to a private equity firm, investing in small privately-owned companies to take advantage of the commodities boom. The minimum investment is $1m. Like a typical hedge fund, the management fee is 2% of the assets under management; performance fees are 20% of any profits. Ambitious bankers, used to making huge profits for their firms, are increasingly doing it for themselves. "If you can make good returns then you deserve it, because it is not easy," she says.

The rewards can be enormous. According to Trader Monthly, the biggest earner last year was Dallas-based T Boone Pickens, who made $1.5bn. In second place Steve Cohen of SAC Capital Advisors made an estimated $1bn. The biggest earner in London was Noam Gottesman, 44, of GLG Partners, who made around $150m. New York remains the centre but London is a clear second and gaining. According to HedgeFund Intelligence, the volume of assets in UK-based hedge funds has grown fourfold since 2002 to $255bn, almost 80% of the total in European funds. At least 100 funds have been launched in Britain this year, many by American expats.

The industry would rather the media avert its eyes, since hedge fund clients are not the types to want attention. But the funds are becoming harder to ignore. The new generation of enormously wealthy fund managers, such as Jonathan Green of GLG Partners, are funnelling money into politics (in his case to the Conservatives). Art prices are being pushed sky-high. Cohen is reckoned to have spent $500m on his collection, including a Van Gogh, a Gauguin and $12m on Damien Hirst's 14ft shark pickled in formaldehyde. In sport, Michael Glazer's takeover of Manchester United was backed by hedge funds. Their wealth is pushing some into celebrity circles, such as the former boyfriend of model Elle Macpherson, EIM's Arpad Busson. Though not all are celebrity material: people in the know suggest the industry has a large share of social oddballs more interested in arcane financial models than the six-foot and shapely kind.


The impact on the financial markets is equally apparent. Ed Burke, fund manager at asset management group Invesco, says that in 1988 hedge funds held just 1% of the market. Today it is about 11%, but their often short-term trading strategies mean their impact on trading volumes is much greater. By some estimates up to half the trading volume on the markets is due to hedge funds. Market turnover has gone from 30-40% to 140% a year. "People are using the market in a fundamentally different way and we have to be aware of it and adapt to it and see the opportunities," he says.

It is the increasing influence of the industry and the lack of transparency that has raised fears that a few wrong bets could bring the whole financial system crashing down. Another common trait of hedge funds is their ability to leverage - borrow and invest more than the assets they have under management.

The term "hedge fund" was coined in the late 1940s. The idea was to invest in shares, but at the same time to hedge bets by shorting others - making a bet that a share price will fall. Regulated investors such as mutual funds are allowed to be "long only": they invest in shares in the expectation that they will rise in value. Shorting remains a widely used strategy in hedge funds but is increasingly just one of many. Some trade commodities, currencies, "events" such as bankruptcies or arbitraging takeovers, macroeconomics, or spot undervalued companies where they can force management change. One American manager described the term hedge fund as "a total misnomer, a terrible name".

The real growth has been in the past 15 years partly because of advancing technology, which allows managers and banks to process very complex trades.

Hedge fund returns over the past couple of years have been down, this year to about 6.9%. Some argue this is because the sector has been swamped. Chicago-based Hedge Fund Research reckons 1,071 funds have been liquidated since 2005 and start-ups this year are down by half. There is an argument that they are being forced to take more risk to differentiate themselves. They continue to look further afield. The actor Tom Cruise, for example, has backing from hedge funds to start a production company. Some of the larger funds with multi-strategies, which even include loan portfolios, have begun looking like investment banks.

There is also a trend among some hedge fund managers to migrate back to the relative comfort of the investment banks, which are only too happy to provide capital for hedge funds under their corporate umbrella.

But it seems unlikely that the growth of the industry will be dampened. "It is the nature of the business that once an inefficiency is identified in the market then people come in and it is corrected," says Andrew Barber at Trader Monthly. "Some of the largest funds have certainly performed with significantly lower returns but at the same time the hedge fund lends itself to extraordinary innovation. I am constantly dazzled by some of the investment strategies from the industry."


Alpha The amount that a hedge fund manager can return above the standard performance of the market. A manager who delivers the same as the rise in the market is returning beta.

Arbitrage Spotting and profiting from the differences in price of a single asset that is traded on more than one market. Often used during mergers and takeovers. In cash deals, the shares in the target often trade below the purchase price. An arbitrageur buys stock of the target and makes a gain if the acquirer ends up buying the stock.

Shorting Unlike ordinary "long" investments, which bank on a share price gaining in value, shorting bets that it will fall. An investor will borrow a share and then sell it, in the hope that it will fall and can be bought back at a cheaper price. The profit is the difference between the two. The name hedge fund has its origins in the concept of "hedging" long investments by shorting others.

Leverage The use of borrowed money to increase a cash investment, something that regulated investment firms like mutual funds are not allowed to do. For leverage to work, the returns must be higher than the cost of the borrowed money. Leverage is risky because you can lose more than the assets under management.

Private equity Sometimes known as venture capital. A private equity firm will invest in companies in the hope of making a profit by selling them on at a later date, either to another buyer or by floating the business on the stock market.

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