In June the world's biggest unions launched a multi-fronted campaign to impact sections of the financial industry, with a series of protests and policy proposals at the G8 meeting of industrial nations in Germany. Members of the International Trade Union Confederation, the world's largest union federation representing more than 168 million workers around the world, pressed various ministers about the problems associated with hedge funds and private equity.1 These two forms of financial operator have both boomed in recent years, and each poses different challenges to corporate citizenship, which were becoming clearer during the first half of 2007.
Hedge funds have boomed since the turn of the millennium while many stock markets were not doing so well. This is because they focused on betting that stocks would go down. They did this by short-selling, which is the practice of borrowing shares with a promise to give them back at a later time. The trader sells them when the share price is high and then buys them back-to fulfil the promise-after that price falls, thus making a profit from a fall in share price. This works well when the interest on the borrowed shares is low, and the time elapsed before buying back the shares is also short, so that overall interest charges do not eat into the difference in share price obtained. Some hedge funds therefore even do these trades in a matter of minutes.
Over 8,000 hedge funds exist, mostly in the US and UK. As their influence has grown, hedge funds have come under attack from regulators, pension funds, and even some business executives complaining about 'short-termism', a lack of transparency, and increased volatility in share prices. The average stock ownership period has fallen during recent years, from an average of two years in 1998, to 14.6 months in 2000 and just 9.4 months now. Some major companies have seen their share prices fall by 30% in a single week after hedge funds have targeted them.2 The problem for corporate citizenship is that this short-term pressure does not encourage companies to plan for the long term and thus invest in research, in staff development, community relations and so forth. Business groups, such as The Conference Board and Business Roundtable, published reports last year that revealed that a focus on short-term earnings undermines companies' ability to create long-term value.
Another reason for notoriety and criticism is the eye-popping amount of money hedge funds make. Hedge fund managers can take 20% of the profits generated in trades, with the top hedge fund manager, Steve Cohen, earning around a billion dollars a year.3 Leaving aside concerns about the ethics of a financial system that can create such earnings amidst such inequality, cumulatively these earnings draw on the collective wealth of the asset owners and employees, an issue we return to below.
This points to the key question about hedge funds: are they good for the economy? If hedge funds make a significant proportion of their money from betting against poor-performing stocks, then do they have an interest in the overall market declining? Man Group CEO Stanley Fink said on the BBC last year that if you think that there will be no union action, no political changes or new regulations, then invest in equities, but if you think there could be, then invest in hedge funds.4 Does that imply Man Group has a strategic interest in volatility, or even in general economic decline? Most hedge funds have an edge because of their short-selling, and so they may have a strategic interest in economic downturn in general, but then that would involve a situation where there would be less money to be made in future, which would reduce the pot from which they can draw: they would have got a bigger piece of a smaller pie.
How have hedge funds responded? Some have parroted the old Milton Friedman rationale that they have created huge wealth for the financial centres that have supported them, like London, and have increased liquidity of money, which they suggest is helpful for the market as a whole. Looking at the corporate social responsibility report of Man Group, the largest hedge fund in the world, the question of the societal benefit or impact of hedging is ignored. It recognises responsibilities to all those with which they have a 'direct relationship' or have an interest in or concern about Man Group, but there is no evidence of the company addressing how its core business impacts on the wider population. Their ethical policy states they will not 'take any stance in respect of politics and religion which is not a neutral one', which seems difficult to square with the important role of financial regulations in providing a framework for instruments such as short-selling, and is not up with the latest thinking on progressive corporate political engagement, described in previous JCC World Reviews.5
More hedge funds floated on stock markets, and attracted large sums from around the world. Man Group financial performance was reported as strong because of Japanese interest in buying shares and giving their money over to manage.6 With all that money coming in, the share price of hedge funds has the potential to do well. But what of the underlying conditions? Hedge funds did well as the market fell but, as the market is on the up, the key innovation of hedge fund-short-selling-is no longer such a great bet. If the new capital injection is herd behaviour, perhaps a hedge fund bubble could be forming.7 The irony would be if a hedge fund manager spotted this and created a fund to short-sell publicly listed hedge funds that focus on short-selling stocks.8 Now that hedge funds can be retailed, such a 'hedge-cutter' fund might attract interest from disgruntled CEOs.