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No amount of lipstick can save these pigs

ddecloet@globeandmail.com

Now that the words "Bay Street" and "Wall Street" are synonymous with panic, fear and plunging asset prices, it's time for an image makeover. A rebranding campaign, if you will.

Let's start by ditching the notion that these are places of finance. In these sullen times, no one wants to contemplate the mental image of arrogant 26-year-olds from Harvard or Queen's pushing paper in their suits, earning six-figure bonuses for securitizing this or leveraging that. So label it something else: Bay Street is really a giant manufacturing operation.

That sounds better, no? But what does it manufacture? Investment products, yes. But what it's really good at is manufacturing euphemisms. Thus a portfolio of risky securities becomes an "investment trust," leveraged buyouts become "private equity," and a package of subprime mortgages backed by overpriced California bungalows is a "structured credit vehicle." Risk is sanitized with soothing language. Here's the best euphemism we've heard about the stock market collapse: It's not a bear market but a "bull market for shorts," a hedge fund manager told us.

But then, the phrase "hedge fund" is itself a subtle evasion of the truth. The term is designed to provide comfort. After all, what's a hedge? "A strategy used to offset investment risk," says the Barron's finance dictionary. Presumably, that means at a time when investors place a higher premium on risk - like right now - you'll avoid the total annihilation of your capital. With hedge funds, you may or may not make money in a down market, but at least you can avoid losing your shirt. That was the sales pitch.

But now the bodies are starting to pile up in hedgeville. Epic Capital is winding down its flagship fund; losses wiped out everything it had gained in the past three years (and then some). A Lawrence & Co. fund nuked 53 per cent of its partners' money in nine months - the victim, apparently, of an untimely margin call that killed an arbitrage bet on Fording Coal. Still unknown is the longer-term fate of a Dynamic hedge fund run by Rohit Sehgal that, through Friday, had dropped 63 per cent this year. The same firm has another fund, run by David Taylor, that's down 54 per cent. It's called Dynamic Contrarian. Contrarian how?

"I've never seen a manager come back from losing more than 50 per cent," says one fund industry exec. But Mr. Sehgal is a big name, a star. So is Frank Mersch, whose Front Street Canadian Hedge fund has done better - it lost 38 per cent this year through Oct. 23, eliminating four years of profits. It's not good enough to say the TSX is having its worst year since John A. Macdonald was a young lawyer in Kingston. If you wanted to lose 38 per cent, you could buy a mutual fund. It's cheaper. Many hedge fund customers are concluding the same thing, and pulling their money. James McGovern, who's the face of the hedge fund industry in Canada, has predicted it could shrink by a third - and he's an optimist. Others believe it's finished, at least in this country.

But that would be dumb. Rather than obliterating the concept of hedge funds, what's really needed is a major rethink of how they work.

What might they look like? For a start, hedge funds could try, you know, hedging. "In many ways, these weren't hedge funds. They were sector funds," says hedge fund manager Paul O'Neil (or, as my colleague Andrew Willis put it, "leveraged resource plays").

But the real trouble with hedge funds is the unhealthy relationship between those who run them and those who put their money into them. It's not so much that the managers take 20 per cent of the profits; it's that when the profits disappear, as often as not, they'll shut down the fund (as Epic is doing) rather than stick around and "work for free." It's not so much that the managers are too obsessed with short-term returns; it's that they practically train their clients to be so, too. Many hedge fund websites publish their returns, month by month, and will brag (or did) that they've only had one losing month in the past 12 or whatever it was, as though that's important. Who can invest properly with a 30-day time horizon?

Hedge funds, per se, aren't evil. It's the people who bastardized them, turned them into vehicles for transferring their clients' wealth into their own, didn't really hedge, borrowed too heavily and ignored risk - they're the ones giving their business a bad name. And now some of those same managers complain that their customers are panicking, and withdrawing money at exactly the wrong time. But what else did they expect?

© 2007 The Globe and Mail. All rights reserved.

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