Return of super-rich hedge funds is nothing to celebrate

‘Hedgies’ have the leverage to make big bets on asset prices. But for the rest of us volatility is disruptive

You could buy as many Swiss mansions or Caribbean penthouses as you wanted. Or most of the Russian oligarchs’ yachts that have been impounded in the swanky ports of Italy and Greece. Or, come to think of it, you could easily afford one of those islands off the coast of New Zealand that are popular with billionaires fearing nuclear catastrophe, or persuade Jeff Bezos to let you take one of his space rockets for a spin so you can take a walk in space.

There are still ways to burn through $16bn (£13bn) if you genuinely put your mind to it. Even so, and even by the standards of the super-rich, the profit the hedge fund Citadel racked up last year is still a lot of money.

Profits are booming, not just at Citadel but right across the industry. The “hedgies” are minting fortunes for themselves on a scale that has not been witnessed since the early 2000s. And yet, while that is great for the traders involved, and probably for their wives’ divorce lawyers as well, it is nothing for the rest of us to celebrate. The big macro funds make their money from extreme volatility, and we have had enough of that for a while; they add very little real value beyond shifting wealth from one place to another; and their super-returns will encourage even more money into the funds when it would be better deployed in genuine investments. The traders of Zug, Mayfair and the Hamptons might award themselves huge bonuses. For the markets, however, it will only mean more money going to the wrong places.

Measured by the sheer amount of money made, it is a remarkable achievement. According to the annual ranking of the top 20 hedge funds by LCH Investments, part of the Edmond de Rothschild Group, Ken Griffin’s Citadel chalked up the largest annual profit ever made in the industry, earning $16bn for itself and its investors. It has overtaken John Paulson’s winnings in 2007 when he made a huge bet against the US sub-prime mortgage market just before it crashed, a play described as “the greatest trade of all time”.

It was not alone, however. Indeed, most of the major hedge funds on the LCH rankings had an exceptional year in 2022. Ray Dalio’s Bridgewater made $6.5bn, DE Shaw took $8.2bn and Millennium made $8bn. Ordinary investors with some money in their Isa, or in a pension fund, might have had a rough ride. For the “hedgies”, however, it has been a fantastic 12 months.

That is great for them of course, and for all the luxury yacht and property agents who count the leading hedge fund managers among their clients. For everyone else, however, there is nothing good about it at all.

First, it was the macro funds that make huge bets on the direction of different assets that really did well. In retrospect that is not terribly surprising. It was a year of extreme volatility. The prices of commodities spiked sharply. Natural gas went through the roof and then fell again. Bond prices slumped as interest rates went up for the first time in almost 15 years. The pound slumped to its lowest level ever and the euro was not much better. The list goes on and on.

It was a year marked by warfare, soaring inflation and financial turmoil. Against that backdrop, hedge funds can make a lot of money. They have the leverage and firepower to make big bets on wild swings in asset prices. But for the rest of us volatility is just disruptive. We could use a lot less of it right now.

Next, the evidence suggests hedge funds add very little real value. True, speculators provide some liquidity to the market – someone was buying the pound in September, for example, when no one else wanted it – in a crisis. They make sure there is always a trade to be done. And yet, in reality, it is quite a limited role. Beyond that speculation has no useful function and often it simply makes a chaotic market even worse.

Thirdly, the optics are terrible. For most ordinary people it has been a tough year. Prices have soared, real living standards have fallen at the fastest rate in a generation, taxes have gone up and even in the once booming tech industry jobs are being lost. Lots of swaggering speculators, who often locate themselves in places where you don’t pay much tax, make it seem as if the financial markets are just about a handful of greedy traders making a fortune for themselves, and that line of attack will, unfortunately, have an element of truth.

Finally, and perhaps worst of all, it will encourage too much money into trading. When you see firms such as Citadel making $16bn in a year, and paying out huge bonuses to the few staff lucky enough to work there, it encourages the smartest, most ambitious people to try their luck in the industry, and investors to hand over their cash to the funds.

But what we need is more money, and the most able people, going into genuine investments. That is the only way we can ever expect to get growth moving again.

In reality, from the days when George Soros made a name for himself as “the man who broke the pound” in the early 1990s to Paulson’s bet against the sub-prime market to Ken Griffin’s record profits in 2022, the super-rich hedge funds add very little to the markets. They don’t create new wealth, they add only marginal liquidity and they divert money from real investment into financial speculation, fuelling the arguments of anticapitalist campaigners at precisely the moment the system needs more support. The fantastic profits over the last year are great for the individuals but they are nothing for the rest of us to cheer.