opportunity to generate exceptional returns .
With gale force winds at their backs , buyout funds produced gargantuan returns in the 1980s . For example , in 1983 , KKR claimed to be generating an average annual return of 62.7 % on its investments . But , as is always the case , exceptional returns attract a stampede of followers . By the 1990s , private equity firms were inundated with far more capital than they could deploy responsibly . Ted Forstmann , who was one of the more disciplined buyout managers , lamented the consequences , stating , “ In the beginning , the innovators of this idea , of whom I was one , had a great deal of discipline … What has happened is imitators flocked in , discipline has eroded , and as a result , breakups that didn ’ t make sense have occurred .”
Forstmann didn ’ t have a name for it , but he was observing the late phase of a typical , alternative investment cycle .
New Haven for Unconventional Investing
“ By operating in the institutional mainstream of short-horizon , uncontroversial opportunities , committee members and staff ensure unspectacular results .”
— David Swensen , late CIO of the Yale Investments Office
In 1985 , James Tobin and William Brainard approached David Swensen with an unsolicited offer to return to Yale
University to oversee its endowment . At the time , Swensen was a rising star at Lehman Brothers , where he established a reputation as an innovative financier . He initially hesitated to accept Yale ’ s offer , as he feared he lacked the necessary experience . But his love of Yale , deep sense of mission and natural talent for teaching outweighed his concerns .
Soon after returning to New Haven , Swensen invited his friend and fellow alum , Dean Takahashi , to join him . At the time , Yale ’ s portfolio was invested primarily in publicly traded stocks , bonds and cash . Swensen and Takahashi believed the allocation was suboptimal considering Yale ’ s long-term return objectives , higherthan-average risk tolerance and limited liquidity constraints . They crafted a new ,
The Return of the Stock Operators
“ We may as well tell the truth and put the blame where it belongs . It ’ s up to Washington now . We have stepped aside … Eventually we will take control again .”
— William C . Durant ( October 1929 )
The stock operators who dominated Wall Street prior to the 1930s wielded a formidable weapon known as the stock pool . Under a pool arrangement , a group of investors consolidated their financial resources . Then , they appointed a pool manager who would use all sorts of nefarious techniques to manipulate the price of a stock to their benefit . But the stock pool disappeared after it was outlawed by the Securities Exchange Act of 1934 .
William Durant , the famed stock operator , foresaw this outcome soon after the Great Crash of 1929 , but he predicted that someday the stock operators would resurrect the stock pool . In 1992 , his prophecy came true when the flawed mechanics of the European Union ( EU )’ s exchange rate mechanism ( ERM ) created a legal application of this forgotten market manipulation technique .
The ERM was intended to keep EU member currencies trading within a narrow band , but maintaining the band required periodic central bank intervention . In 1992 , the pound sterling depreciated too far relative to the German mark . The Bank of England ( BoE ) purchased pounds aggressively to prop up its value . Observing the BoE ’ s efforts , co-founders of the Quantum Fund , George Soros and Stanley Druckenmiller , calculated that the BoE lacked sufficient foreign exchange reserves to remain in the ERM . If the BoE failed , they would abandon the ERM , which would cause the pound sterling to depreciate sharply .
Soros and Druckenmiller knew that shorting the pound promised enormous profits , but it required selling pressure that was beyond their ability . They addressed this problem by sharing the plan with several hedge fund managers , and the group formed a virtual stock pool to short the pound . As predicted , massive selling pressure forced the BoE to abandon the ERM . After covering their short position , the Quantum Fund alone made a $ 1.5 billion .
Wall Streeters were awed by the profits but were even more excited about the return of the stock pool . The “ Breaking of the Bank of England ” triggered rapid growth of hedge fund assets under management ( AuM ). In 1990 , hedge fund AuM was less than $ 10 billion . By 2000 , it exceeded $ 250 billion . But unlike buyout and VC funds , hedge fund growth was driven primarily by a fleeting opportunity . The resurrection of the stock pool was an anomaly that was not expected to last . Nevertheless , once the stock operators regained a foothold , they refused to yield . In 2024 , hedge funds hold more than $ 5 trillion of AuM .
12 FINANCIAL HISTORY | Fall 2024 | www . MoAF . org