Hedge funds... friends or foes?

Foreign affairs have a good article about the role of hedge funds. The article also points that even though hedge funds have received a lot of heat over the years they actually perform an important role with regards to liquidity and risk management. Here is a brief summary:

The massive growth of hedge funds has sparked warnings of instability and demands that the industry be regulated. But the fear of hedge funds is overblown, based on a misunderstanding of their role in the international Þnancial system. In reality, hedge funds do not increase risk; they manage it -- and policymakers, rather than clamping down, should make sure hedge funds have the tools to perform this function well

Are PE firms actually conglomerates? And is it actually a problem?

A recent article in the economist argues that PE firms are looking very much like conglomerates. However, according to a study by BCG, this does not seem to be a problem, as diversified firms, e.g. conglomerates, are increasingly able to achieve superior returns by doing exactly what PE firms are doing.

ARE private-equity firms the new conglomerates? The two look more and more alike. The dozen or so top private-equity firms have taken positions in an extraordinarily diverse range of operating companies, much as big conglomerates have done.

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But the comparison is one that the private-equity firms have discouraged. After a fashion for industrial conglomerates peaked in America in the early 1970s, the term became a pejorative one among students of business. It came to signify inefficient management; a failure to master the demands of wildly different businesses; an absence of focus.

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The private-equity firms might want to know, however, that just as they are shunning the label of “conglomerate”, the term may be on the way back into fashion. A well-run conglomerate may be admirable after all. That, at least, is the message of a new study by the Boston Consulting Group, “Managing for Value: How the World’s Top Diversified Companies Produce Superior Shareholder Returns”.

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The study looks at 300 of the world’s biggest firms, some 30 of which are classic diversified conglomerates. It finds that most of the diversified firms outperformed stockmarket averages in the past five years, many by a significant margin. An average focused company in the study did even better, but this result was distorted by a handful of exceptional performers. Most of the focused companies failed to perform as well as the diversified companies.

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How did the better conglomerates do so well? For the most part, by behaving rather like private-equity firms. A successful conglomerate had a lean organisational structure; it had a consistent strategy for its portfolio companies, viewing them as trading assets, or holding and managing them for the long-run. And it was extremely efficient at allocating capital. It invested most heavily in its profitable units. That might sound like common sense. But over-investing in underperforming subsidiaries was a common problem among weak conglomerates in the study.

Risk and return

The example is from the Economist

The failure of torcetrapib is also a reminder that drug development is an extremely high cost, high-risk activity, and that the most promising new drugs can go wrong even at a late stage. In 2004 Pfizer pledged to spend $800m getting torcetrapib to market, an investment that may now be worthless. And such failures are hardly unusual. In the heart disease area, recent disappointing examples include AstraZeneca’s blood-thinner, Exanta, and Bristol-Myers Squibb’s blood-pressure-reducing drug, Vanlev. Merck is caught up in a costly legal battle following the withdrawal of its pain-killer, Vioxx, in 2004. Side-effects were discovered after Vioxx had gone to market. That failure cost Merck’s then-boss, Raymond Gilmartin, his job

This high failure rate explains why drug firms need to earn huge profits, for a while, on those drugs that do reach the market successfully. It explains why anyone who wants the drugs industry to be as innovative as possible―which is all of us, surely?―should oppose moves to impose limits on the pricing of new drugs, an idea now being actively considered in Washington, DC, by politicians who seem more desperate to cut the cost of health care than to improve its quality.

It's all about scarcity of resources

There has been rumours going on for quite sometime that Google has started to lower their requirements to new hires(unfortunately I cannot remember where;)), but as it is apparant from this article it seems that Google still have some of the "smartest guys in the room". Nevertheless, as it is apparent from the citation below to many smart people may cause problems...

Every company wants to hire the smartest people possible, and Google has clearly succeeded. But you know what you get when you get too many smart people in one room? You get the corporate equivalent of the U.S. Olympic basketball team.

Think about it: there can only be one smartest person in every room. There are dozens of trophy hires and incredibly smart, entrepreneurial minds buried inside Google who are fast-becoming frustrated with their inability to accomplish anything. And while Google motors along, minting money with its AdSense and AdWords programs, these brilliant minds are getting antsy.

Armed with seven-figure bank accounts and professional networks of dozens of other equally brilliant and rich new friends, those frustrated Googlers are bound to
set out on their own and ignite a son-of-Google wave of innovation.