“I think one has to be fairly honest about a lot of lucky things that have happened,” Cliff Asness EAS’88 W’88 is saying. “I think too many people who are successful love to attribute it all to their own skill or decisions or acumen. And some of that is true—but a lot of that isn’t.”

Asness is sitting in his sunlit corner office, with a view of the Greenwich, Connecticut harbor and the Long Island Sound in the distance. His modesty is both disarming and somewhat unusual in the hedge-fund business. Even more unusual is the fact that he has allowed a writer to visit him at his hedge fund, AQR Capital, and ask a wide range of questions about investing strategies and his role in the finance industry—and that there are no lawyers present.

Asness speaks in rapid staccato, with the energy and enthusiasm of a young graduate student whose thesis could break new ground in his field. And, in fact, he was a graduate student in finance not long ago, designing quantitative models and testing new theories on investing in speculative markets. That he and the dozens of other Penn alumni who developed their own investment firms in the past 20 years have become successful financial managers is not necessarily surprising. That they did it by bucking the established investment banks and large-asset management firms—and are in the process of turning the financial world on its side—borders on the astounding.

Hedge funds represent a relatively pure, unregulated form of high-risk capitalism. Whether they will continue to stay unregulated, and continue to offer a lucrative way of navigating the treacherous shoals of the market, is unknown.

In 2005, according to CNNMoney.com, a record number of new hedge funds were created—2,073, compared with 1,435 created in 2004—but another 848 were liquidated, also a record. Today there are approximately 8,500 hedge funds in existence, with combined assets of more than $1 trillion, up from $400 billion five years ago. From 1987 through 2004, hedge funds returned an average of 14.94 percent a year once fees were deducted, according to The Hennessee Group, which tracks industry funds. The Standard & Poor’s 500 funds, by comparison, returned 11.88 percent. But in 2004 hedge funds compared less favorably, returning 8.3 percent compared with 10.87 percent for the S&P 500.

On June 22, The Wall Street Journal ran a piece titled “Hedge Funds Hit Rough Weather But Stay Course,” which noted that, amid the “market tumult of the past two months, a handful of hedge funds have shut down,” including the Ospraie Point Fund, Saranac Capital Management, and a significant part of KBC Alternative Investment Management. (The most spectacular shutdown came in 1998, when Long-Term Capital Management all but collapsed, dumping securities around the world and wreaking havoc on international financial markets.) But, the Journal added, “even as markets have become tougher to navigate, problems among hedge funds remain fairly well contained.” And as long as they offer a way for investors to make significant money, they will survive.

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©2006 The Pennsylvania Gazette
Last modified 08/31/06

Betting Their Hedges
By Aaron Short

Illustration by Franklin Hammond

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Hedge funds are risky—and sometimes highly lucrative. A growing number of Penn alumni find that combination irresistible. By Aaron Short