While hedge funds as a whole have failed to deliver their investors a higher return than T-Bills1, there are a few that have provided above-market returns. One of them is Steven Cohen’s SAC Capital, which is now the subject of an ongoing FBI/SEC investigation of insider trading that made the cover of Bloomberg Businessweek in a very well-written article by Sheelah Kolhatkar. While it is too early to determine if Cohen will meet the same fate as Raj Rajaratnam of the Galleon Group who is currently serving an 11-year prison sentence, the FBI is working hard to flip one of Cohen’s underlings. As we have often pointed out at Index Funds Advisors, consistently beating an efficient market is usually the result of insider information. In trader jargon, it is referred to as a “black edge.” One trader turned witness opined that a hedge fund that refrained from using insider information would not be expected to survive. As Kolhatkar brilliantly put it, “Trading on nonpublic material information is similar to doping in professional cycling: Once someone like Lance Armstrong starts doing it, everyone else has to as well.”
So the prevailing question for any hedge fund operator is, “How do I get an edge so that I am not left behind?” One way, perhaps the oldest way in the world, is made apparent in a salacious help wanted ad on backpage.com. Since I cannot do justice by quoting part of it, here is the whole ad (except for the contact information):
Secret Agents Needed
Do you have an open mind, a sense of adventure and the desire to make some serious cash? We’re a group that specializes in extracting key pieces of information from business leaders by seducing them with beautiful ladies such as yourself. Each assignment pays between $5k and $20k depending on the value of the information and how long it takes to obtain it. We also reimburse for travel expenses, if any. We have immediate needs for beautiful, sophisticated ladies who will do anything it takes to find out what we need to know! Please send photos and tell us something about yourself.
Those who followed the Rajaratnam case will recall Danielle Chiese, the femme fatale who acquired information in the manner described above. She is now serving a 30-month sentence at the same federal prison that hosted Martha Stewart a few years ago, also in connection to trading on insider information. In one of her more colorful recorded conversations, she boasted of “playing” one of her paramours “like a finely tuned piano.” It is not difficult to understand why Forbes magazine designated hedge funds as The Sleaziest Show on Earth.
As always, IFA counsels investors that rather than striving to beat the market, they should view the market as an ally whose returns are there for the taking. Lastly, if anyone does come across material non-public information, they should contemplate how they would look in an orange jumpsuit before acting on it.
1Simon Lack, The Hedge Fund Mirage (New Jersey: John Wiley & Sons, Inc., 2012).