As it turns out, it was the big regulated entities, the banks and investment banks, that were the problem, not the unregulated hedge funds

TO BE NOTED: From the NY Times:

Talking Business

Hedge Fund Manager’s Farewell

By JOE NOCERA

Two weeks from now, a seven-year-old hedge fund called Alson Capital Partners will return around $800 million to its investors, and shut its doors for good.

The fund was founded and managed by Neil Barsky, 51, a former Wall Street Journal reporter-turned-Morgan Stanley analyst, who started his first hedge fund in 1998, just as the “hedge fund decade” was gaining steam. He was an old-fashioned stock picker who ran Alson Capital as a classic “long-short” stock fund, meaning that he bought companies he thought had good long-term prospects, while shorting companies he thought were likely to fall off the cliff. At its peak, Alson Capital had $3.5 billion under management, charged a 1.5 percent management fee, took 20 percent of the profits, and, when you include Mr. Barsky’s predecessor fund, produced compounded annualized returns of 12.11 percent a year. It’s fair to say he’s made a pretty penny.

Mr. Barsky is also a source of mine. In the decade or so that I’ve known him, I was able to quote him by name only once. As he explained to me recently, hedge fund managers who become too visible can make their investors wonder, “Why are you spending all your time on TV when you should be managing my money?” But he was one of the people I turned to when I wanted to learn what was really going on in the market. He is blunt, sardonic, funny and passionate, an insider who never lost his outsider’s perspective.

So when I read that he was quitting, I went to see him. I was hoping he would be willing to reflect on his life and times as a hedge fund manager, on the record this time. Happily, he was.

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A bit of context first. For all the talk these last few years about the risks to investors of “secretive, unregulated” hedge funds, they certainly haven’t turned out to be the big problem, have they? Like most hedge funds, Alson Capital had a rough year in 2008, down more than 20 percent. Indeed, thousands of hedge funds lost, in the aggregate, hundreds of billions of dollars last year, and hundreds have shut down. But nobody in government is calling for a hedge fund bailout because hedge funds losses, however painful to investors, don’t create systemic risks to the nation’s financial apparatus. As it turns out, it was the big regulated entities, the banks and investment banks, that were the problem, not the unregulated hedge funds.

Why did all the fear about hedge funds turn out to be unjustified? One reason is that most hedge funds didn’t have the kind of 30-1 leverage ratios that the big banks had. Mr. Barsky’s fund, for instance, didn’t need much leverage to carry out his long-short strategy. But even if he had wanted to “lever up,” as they say, his prime broker — that is, the investment bank that did his back-office work — probably wouldn’t have let him.

In a wonderful irony, the banks and investment banks that were themselves drowning in debt were fearful of allowing their hedge fund clients to carry too much debt. They still remembered Long Term Capital Management, a hedge fund that a decade earlier had, indeed, brought the financial system to the brink because of its extreme leverage.

The second reason is that, while hedge fund managers could make extraordinary sums, they had far fewer incentives than Wall Street traders to take truly insane risks. “Ninety percent of my net worth was in the fund,” said Mr. Barsky, and that is true of most hedge fund managers. Wall Street traders got rich by making deals that brought short-term profits, even if they “blew up” later. Hedge fund managers who blew up hurt not only their investors but themselves. “As long as the hedge fund manager has his own capital in the fund, the risk equation is different,” Mr. Barsky said.

Although his fund lost money in 2008, it did not blow up; as he put it, the 20 percent loss was “not a disaster but not good.” Although he was forced to make redemptions to investors who bailed out, enough remained that he could have stayed in business. What really caused him to exit the hedge fund business is that he felt ground down by the relentlessness of the job.

“When you manage a hedge fund,” Mr. Barsky said, “the cost is the incredible stress you endure. You can never escape it. You are never free. The thing that is different about running a hedge fund is that your investors own you.”

The goal of a hedge fund manager is not to beat an index, as it is for a mutual fund manager, but to generate positive returns no matter what the market is doing. Failure to do so would invariably mean redemptions, and could often mean the end of the business. “Hedge funds are fragile,” Mr. Barsky said. Over the years, I could always tell when Mr. Barsky was feeling especially stressed; he did not hide it well.

He was also tired of the ways the business had changed. “When I first started in 1998, we used to send out quarterly numbers. Now investors want weekly numbers. Professor Louis Lowenstein” — the iconoclastic and recently deceased Columbia University business law professor — “has a great line in one of his books: ‘You manage what you measure.’ ”

Mr. Barsky shrugged, as if to say: don’t feel sorry for me. “That’s life,” he said. “None of us should ever lose sight of the fact that we were in one of the most profitable industries ever. I’m just saying it became a little less fun. And last year was no fun at all.”

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Finally, though, Mr. Barsky felt that staying in business would mean having to operate in an investing environment that he no longer quite understood. Making macro bets about the economy was suddenly more important than individual stock picking. And that wasn’t his strength. Besides, at 51, he felt he had another act left in him, and he wanted to find out where life might take him if he were no longer in the business of running money, particularly in the arena of public policy, which fascinates him. “So,” he concluded, “giving people their money back was the best course for everyone.”

Although Mr. Barsky has clearly gotten rich, he was surprisingly clear-eyed about the societal imbalances of hedge fund mania. The industry, he told me, “was part of this huge trend towards the celebration of wealth. Hedge fund managers overearned. It just became too easy. There has been a massive misallocation of human resources. I have so many smart guys here who were making seven figures. And I think it is a fair question to ask: what would they have been doing in 1948 — going into the foreign service? If Obama does anything, the best thing he could do is change a generation’s values.”

He continued: “I have a friend whose son is a senior at Princeton. She said all his friends want to work for Goldman Sachs.” He added, “We have an overground railroad to finance. It is not the best way for a society to be run.”

One of the things that struck him when he first started working on Wall Street, he said, was “how compensation-oriented Wall Street is. When I was a journalist, I could get rewarded in 100 ways, including being on Page 1. Wall Street is the other extreme. There is a singular focus on compensation that is simple, it is clean, but ultimately it is unhealthy.” He thought the outcry over the Merrill bonuses was helping the rest of the country see Wall Street’s skewed priorities more clearly.

Earlier in his career, while still at Morgan Stanley, Mr. Barsky helped edit “Buffett: The Making of an American Capitalist,” written by his good friend, the writer Roger Lowenstein (who is also Louis Lowenstein’s son). As he talked about that experience, I asked him if he had modeled his own investing style on Warren Buffett. He let out a small chuckle.

Then he stood up and walked over to his desk, where he showed me two framed letters, one he had sent to Mr. Buffett, and the Oracle of Omaha’s reply. They were written in the fall of 2000, shortly after Viacom had spun off its Blockbuster unit. Mr. Barsky had bought the stock — and then had written to Mr. Buffett suggesting that he buy the company.

Mr. Buffett sent back a one-sentence reply: “I’ve thought about the business a lot but have never been able to come up with a conviction as to where the industry will be in 10 years.”

“Ten years!” Mr. Barsky said. “I think of myself as a long-term investor and I have a two- or three-year horizon.” He shook his head. “In addition to an outsize intellect, Buffett has something that very few investors have. He has a temperament that makes him suitable to being a great long-term investor.”

“I don’t feel a sense of defeat,” Mr. Barsky said, as I was preparing to leave. “We have done well by investors and by our employees. We comported ourselves ethically. Three months ago,” he added, “I started to read books on Buddhism. What I learned is how much of what we do is ego-driven. Why do I feel I have to be the best hedge fund manager? I started to have perspective. You probably want your hedge fund manager to eat raw meat. But as we unwind, I’m pretty comfortable with my mind-set.”

Sounds like he’s getting out just in time."