Hedge Funds Keep Watch on Washington

Calling all wonks: The expanded role of the federal government in the markets and economy is forcing hedge fund managers to turn to policy experts

By David Bogoslaw

As legislators and officials in the Obama Administration debate and potentially draw closer to passing new rules regarding health care, carbon emissions, and financial services, hedge fund managers are awakening to the need to reexamine the assumptions they have long held about government's role in the private sector.

This renewed focus on all things macro—from economic policy to regulatory regimes—is spurring hedge fund managers to seek the counsel of policy experts who can help them better grasp the broader context required to make investment decisions in the years ahead.

There has been a dramatic increase in requests for consultations with policy experts coming from hedge funds and private equity firms, says Andrew Goldman, managing director of marketing, communications, and public policy at Gerson Lehrman Group, a consulting firm with 17 offices around the world. GLG, whose platform allows investment managers to collaborate and consult with experts in a wide range of industries and policy fields, has more than 300 hedge funds and over 250 private equity firms as clients.

"A year ago, we got a real surge in such activity around the time of the [financial] meltdown in Iceland," says Goldman. "We started pulling in the former Prime Minister of Iceland and had an enormous number of hedge funds in the U.S. who wanted to speak with him." The sharp increase in public debt in Austria and passage of the $750 billion Troubled Asset Relief Program (TARP) also prompted many requests for consultations with experts in Vienna and former Treasury Dept. officials under the Bush Administration.

One client who runs a $4 billion hedge fund in San Francisco that employs 25 researchers recently told GLG that while he never expected Washington to become "the financial capital of the world, now that it is, I have to understand" how it works, says Goldman.

Think Tanks First, Then Lobbyists

Investors trying to make money from investments tied in some way to policy strategies need to first focus on context to inform their investment decisions. "What is it policymakers want to accomplish [with a certain initiative]?" asks Jason Bajaj, global macro manager at hedge fund Outpost Investment Group until mid-July. "Once you understand, to a certain degree, what the context of the policy idea is, the next thing is to focus on implementation. Does it become legislation, or government intervention, to back the idea up?"

He recommends that hedge fund managers talk to analysts at Washington think tanks such as the Brookings Institution and staff members in government agencies where relevant policy debates are taking place just to grasp how each political party is looking at a policy issue. Then, lobbyists and lawyers at law firms that are typically hired to draft legislation can give fund managers a better sense of what's entailed in implementing a policy.

The more astute hedge fund managers have long been factoring policy considerations into their investment decisions, according to Michael Harron, managing partner at TMF Capital Management in Chicago. He suspects the recent uptick in demand for consulting services is coming mostly from the large number of new hedge fund managers focused on the comparatively broad field of event-driven investing, which bets on the outcomes of legal cases, policy changes, and other shifts within companies or industries.

Lately, hedge fund managers have been requesting consultations with experts in health care and climate change and environmental policy. Contentious debate over the viability of a government-sponsored insurance plan that would compete with private insurance companies and how the government would pay for it has garnered most of the media attention, but the implications of health-care reform for pharmaceutical companies are also subject to debate.

Digging Deeper

Hedge funds are trying to figure out "on a more granular level than in the past who the winners and losers will be, using specific details about the legislative process," says Richard Tarplin, whose firm, Tarplin Strategies, provides advice and lobbying services to clients in the financial-services and health-care industries and who has consulted with several fund managers. For example, investors want to know exactly how various provisions in the bills will affect the ability of insurance providers to set prices in the future, or the implications for a hospital's profits five and 10 years from now. "It's hard to tell the winners and losers until the process is done," he adds.

Tarplin has told fund managers while he believes insurance firms will largely dodge a bullet under any new legislation, they will likely take a hit on the Medicare Advantage program, whose budget will probably be cut by more than $100 billion over the next 10 years. "That's the price they're willing to pay if they get other things like an individual mandate for everybody who has to purchase insurance," he says.

Managers of pension funds and endowments have told Stephen Czech, chief investment officer of a New York-based direct lending fund, that they're shying away from event-driven strategies in highly regulated industries until the regulatory dust in Washington settles. Czech believes hedge funds have similar reservations about any industry facing heavy regulatory changes. The more regulated an industry, the greater the odds that the rules can change overnight. That's too big a risk for investors who have modeled their investment return calculations on certain assumptions.

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