Thursday, March 27

Hedge Funds versus Charities

I first read this article where the Bishop of Rochester, Michael Nazir-Ali told off hedge fund managers for not being charitable enough and I quote:

“The turmoil in the markets is almost certainly the result of amoral forces,” Nazir-Ali told his flock. “Those with power need to ensure that the poor are not disproportionately affected.”

“From possessiveness we need to move to gratitude for what we have,” he added. “When that happens, hedge fund managers and directors of companies can indeed go into the kingdom of heaven ahead of the chief priests and elders.”

I was quite amused by this statement. Are you really sure that hedgies and Directors are motivated by the possibility of entering heaven earlier than priests and elders? I dont think so, Bishop.

But then, it got me thinking. Bear with me...

Let us compare them with a charity, ok? A charity generally spends about 13-14% on management and administration fees. In other words, out of £100 that it gets in contributions and grants, on an average, it manages to spend £86 on the objective (on food, orphans, animals, starving rare dung beetles, or what have you). I have not heard of charities investing their own funds so I am presuming that whatever comes in, goes straight out less admin fees. (If they do invest, say in gilts, assuming 1.2% return, you are looking at perhaps a quid or two more maximum).

But look at hedge funds. Hedge funds generally charge 2% management fee and 20% of the return. Last year, the average hedge fund return after fees was about 13%. So lets apply those figures to a theoretical £100 investment in a hedge fund. £100 less 2% management fee =£98. A return of 13% gives me £12.74 and I take away 20% from it leaving me with £10.192 return. So I withdraw £98 as my principal, add £10.192 and I end up with £108.192 compared to £86 from a charity.

Assume tax equalisation happens and even if charities are tax free and hedge fund returns for charity taxed, taxation is not that much. So if you consider that the return is taxed at 20%, we will still be quids-in compared to a charity.

So, basically, if the objective was value addition and giving the maximum possible benefit out of contributions, then you will be better off giving money to a Hedge Fund and getting that money to the ultimate recipient. I know this is very simplistic, and you cannot really invest say a typical £10 donation into a hedge fund, but that's just logistics, a collection logistics system can be easily established which feeds small sums of money into the fund.

This reminds me of the day when I was asked by somebody to advice on investment opportunities around the world while their cost of capital was about 10% and expected return was about 14%. They particularly wanted to invest in Russia and my suggestion to them was to forget about setting up a manufacturing plant in Russia and to invest their cash in Russian Government Bonds, which were, at that time, providing over 35% return....

As a matter of fact, the Bishop should consider his own backyard. His pension fund is £125 million in the deficit with assets of £325m (as at 30/9/05). The actuarial letter of 15th of February 2006 is predicting that they are working on the assumption that the current return would be about 1.2% (if invested in index linked gilts) or 2.2% (if invested in equities) (See here for details of the Anglican Church's pension fund from where I am quoting these figures). So actually, I would rather suggest to the Bishop that he doesn't moan about the hedgies but take his £325 million and quietly go to a fund of funds fund and ask them to pretty please improve his pension otherwise they are looking at a massive gaping hole of almost a third of assets. And you cant really sell off the Rochester Cathedral to fund pensions, can you?

But that said, hedge funds are massive philanthropists. Take for example, The Children's Investment Fund. A very large proportion of its profits are given to The Children’s Investment Fund Foundation, one of the largest charities in the UK. (Disclosure: I am currently working in an institution which is linked to this hedge fund) (Take a look at some of the external links on the charitable activities on the wiki page here). So before he takes off and blames hedgies, he might want to rethink the benefit of hedge funds!

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