London's earning

Not since the loadsamoney Eighties has Britain had it so good. The colossal deals of the capital’s private equity magnates have created a ‘national wealth service’. But Brown’s controversial tax loopholes and the ever-growing disparity between rich and poor have kick-started a moral backlash. Ned Temko enters the secretive world of hedgies, quants and non-doms

Sunday July 15, 2007
The Observer

Times are good for Patrick. At Christmas, he boarded a private jet for a ski break with a few workmates in Zermatt. Since then, he has spent a weekend fooling around in the English countryside in a £200,000 supercar, helicoptered off for an afternoon at Goodwood’s Festival of Speed, enjoyed a private showing of Damien Hirst’s famously bejewelled human skull, and, just last week, accepted a £5m offer on his gadget-filled South Kensington flat.

And the remarkable thing is that by the standards of London 2007, Patrick’s not really rich. ‘Nowhere near,’ to use his phrase. He may fly by private jet but he doesn’t actually own one. The supercar isn’t his either. It’s part of a £13,000-a-year ‘car club’ – not the kind where you share a single Prius for the school run and save the planet, but which loans out the latest Ferraris or Maseratis for a few days at a time.

One final thing. Patrick is also – it pains me to report for the purposes of what should have been a perfectly straightforward morality tale – a thoroughly nice guy. He works hard. He is frighteningly numerate, which, since he is a partner in one of Britain’s leading hedge funds, he has to be. He is funny. He talks engagingly about film and literature, sport and politics. He pays his full whack of UK taxes. He gives to charity. The only crime he regularly commits is artfully dodging speed cameras.

But he is rich, and with the prospect of a partner’s bonus likely to dwarf the price tag on his flat, he is getting steadily, inexorably richer. He and his even wealthier fellow hedge fund managers (or ‘hedgies’) – along with private equity magnates such as Sir Ronald Cohen (friend and confidant of Gordon Brown) and resident foreign billionaires like Roman Abramovich (friend and confidant of Vladimir Putin) – have fuelled an explosion of wealth that has transformed the face of London since New Labour came to power a decade ago.

They have pushed property prices in Kensington, Chelsea, Belgravia and Hampstead into the stratosphere, with a clutch of recent £4,000-per-square-foot sales outstripping even Monte Carlo. In June, a duplex ‘flat’ stretching across two listed houses in Lowndes Square – the haven close to Harrods and Harvey Nichols where the newly arrived Abramovich lived before selling up a few years ago – sold for a record £16m.

They have also poured millions into the tills of the area’s luxury shops, King’s Road boutiques and the archipelago of pricey restaurants that surround them. And the London art sales. At their auctions last month, Sotheby’s and Christie’s sold works totalling an unheard of £414m, trumpeting the city’s challenge – in the art market as in the financial markets – to the dominance of New York.

The British capital’s new rich have spawned a whole range of businesses and services dedicated simply to helping them find ways to spend their money. Patrick’s car club is small change. Armies of personal buyers and fixers now make a living arranging the perfect party, scouting out the latest yacht or jet, millionaires-only hotel or imaginative holiday destination, or helping to find a second or third family home for downtime abroad. Favoured choices include Antibes and Lake Como.

It is little wonder, given the amount of disposable cash at their clients’ command. Hungry hedgies, it is said, can spend upwards of £5,000 for a meal at Scott’s or other favoured Mayfair retreats – ‘It’s not the food bill, but the wine,’ Patrick explains. Others pay up to £35,000 for a place in the Royal Opera’s ‘First Night Club’, guaranteeing four opening-night seats in Covent Garden as well as a lavish meal at the Floral Hall Balconies restaurant.

And last month, a 38-year-old Danish-born hedge fund trader with London’s MAN group forked out an ‘easily affordable’ £100,000 for a place on one of the 150-minute sub-orbital ‘space tourism’ flights Richard Branson is planning to launch in 2009. ‘I’ve travelled to 50 countries, seen the rainforests and even dived with sharks,’ Per Wimmer explained. Having dreamed of space flight since childhood, he said, ‘This seemed the obvious next step.’

The upmarket magazine stable of publisher Conde Nast – GQ, Vogue, Vanity Fair – has been joined by a new title, Portfolio, targeted not only at New York money but at the hedgies, equity managers and other assorted super rich of London. Its launch issue, in May, was full of lifestyle pieces – as well as a devastating Tom Wolfe portrait of hedgies as the new, testosterone-stoked Masters of the Universe. ‘But the odd thing,’ remarks one Conde Nast executive, ‘is that one of the responses from readers was: “Why are there so many ads?”‘ He smiles, as if to say: that’s a bit like a scuba diver going into a sports shop and wondering why there are wetsuits.

The ads were a wonderful window into the world of the new rich: cars and jets and clothes. And wristwatches. Not your ordinary Rolex: that’s just an everyday piece for the hedgie who has everything. But, as Portfolio’s style page memorably puts it, Big Swinging Ticks. The pick of the crop, for a cool £100,000, was the Richard Mille RM002-V2.

The problem for Britain’s new rich is that for the first time since the crashing finale of Margaret Thatcher’s loadsamoney Eighties, there are suddenly big looming storm clouds on the horizon. The millions haven’t stopped pouring in, at least not yet, and there is no imminent . sign that this will happen. The heavy weather is political, and it began with an assault not on the hedgies, who are the fastest-growing source of the capital’s superwealth, but on private equity bosses, who are the most visible.

They used to be known as venture capitalists, and did pretty much what they said on the tin. They identified promising new business ventures, strong on ideas but short of cash, and backed them – with often spectacular returns. But with their bank accounts bursting, borrowing rates low, and the number of likely looking business start-ups limited, they began buying into existing companies. They re-engineered them, made them leaner and meaner – again with often spectacular results.

Leaner and meaner, however, almost always meant job cuts. When the equity funds began targeting household-name brands such as Birds Eye and Boots and the AA, the backlash came. It began in earnest with the AA, where some 3,400 workers have been laid off, and was led by the trade unions. At first, the issue was jobs. But, very quickly, it was also about the disparity between the plight of the jobless at AA and the fund managers with their big bank accounts, big houses and Big Swinging Ticks.

And about tax – about how little of it, at least in percentage terms, the people with the most money appeared to be paying. Private equity partners benefited from a perk introduced by Gordon Brown called ‘taper relief’. In most cases, this meant they could pay a mere 10 per cent – rather than the top 40 per cent income tax rate – on gains from their buyouts. And there was more. Many of the private equity multimillionaires, though they lived and worked in London, were ‘domiciled’ overseas for tax purposes. This meant that such ‘non-doms’ could pay no UK tax at all on ‘earnings abroad’ – which, with the help of any half-decent accountant, could amount to a very large chunk of their wealth. That Brownite loophole earned Britain the dubious honour earlier this year of being formally classed a tax haven by the IMF.

The battle over private equity has quickly escalated, primed by one equity man’s public admission that he paid a lower tax rate than his cleaner. The Commons Treasury Select Committee announced a series of hearings. At the first one, the spokesman for the trade body of British private equity was made to look so haplessly out of touch with the political crisis about to engulf his bosses that he ended up having to fall on his sword a few days later. Session two, with the MPs visibly armed and ready to take on the private equity bigwigs themselves, ended, perhaps predictably, in a score-draw.

But the storm has not gone away. While private equity can, and will, make the argument that putting huge sums of money into underperforming businesses promises more jobs in the long run, the issue of taxes – of wealth, of fairness – clearly has political legs. The unions may have kicked it off, but it has since generated headlines not only in the Guardian but the Daily Mail, and words of warning not only from Labour’s Roy Hattersley but the Tories’ shadow chancellor, George Osborne.

And crucially, the controversy has erupted just as Brown the chancellor has moved from Number 11 to Number 10 Downing Street.

Intriguingly, the new prime minister and the new rich have a considerable amount in common. For a start, they look at the world – or at least the part of it that involves markets and money, economies and jobs – in much the same way. For Brown, the challenge is to make Britain competitive in a ‘global’ century where almost anything that can be made by human hands can be churned out more cheaply in China or India, and where the mountains of cash that fund the making and the buying and selling can be kept and managed as easily in New York or Hong Kong as in London.

So while Brown may well come to regret his ‘taper relief’ or ‘non-dom’ loopholes, he – and the super rich they’re helping – both know that if and when they’re closed, many will either find new forms of creative accountancy, or simply take themselves and their business elsewhere.

But there are less obvious bonds, too. Except for the fact that the tycoons have and enjoy money, and Gordon Brown quite genuinely does neither, he respects their drive, their success, their often overlooked millions for charity. And while he would no doubt have gladly seen the callow and conspicuous rich kids of the Eighties boom stripped of their last yellow Lamborghini, the new rich, or at least many of the richest of them, are a different breed – in extraordinary ways, more than a little like the new prime minister.

So who are these guys? The first thing to recognise is that, with very few exceptions, they are guys. Search the richest in the rich lists and you’d be hard put to find any with more than a single X chromosome. And they are not the new rich for nothing. They may not, like Brown, have worked their way up to the highest office in the land from a humble Kirkcaldy manse. But to a remarkable extent, they are outsiders, and not just those who are foreigners. A surprising number began with next to nothing. Even those who didn’t, scrapped. They grafted. If at key points they have been lucky, too, they weren’t handed their fortune. They grabbed it. And, having got it, as Brown’s long trek to Number 10 leaves him especially equipped to understand, they are that much more keen to stay at the top.

They are also clever. They have had to be. ‘In the Eighties, the Big Bang had just happened,’ Patrick reflects. ‘The markets were booming. People like me used to stand on a London trading floor with a telephone to our ear. We would field calls from people who wanted to buy, or people wanted to sell, and all we had to do was cream off the earnings. Anyone with half a brain could make money. Kids with less than half a brain got their Lamborghinis!’

And Britain’s new rich – or at least many of the biggest hitters – are Brownite in more fundamental ways. They are instinctively private. They shun conspicuous consumption, in part no doubt because they’re so wealthy …#8594;…#8592; they don’t have to show it, except in the company of one another. And they are far more comfortable with a balance sheet, or ticking off agenda items at a planning meeting, than making small talk over canapes. There is a quip that was coined to describe the group known as ‘quants’ – the often almost asocially focused analysts, many with maths PhDs, who work in the engine room of the hedge funds. ‘They knock,’ it is said, ‘at the door to their own office.’ It is a phrase that could be applied to Gordon Brown, or to his closest ally among the new rich: Sir Ronald Cohen.

Cohen, who lives an opulent but guardedly private life in Notting Hill, can justifiably claim to have invented private equity in Britain. It was, like Brown’s, a success that at times must have seen unlikely. He was born into a Sephardi Jewish family in Cairo who fled to England after the Suez crisis in 1956. Enrolled in a north London grammar school, he earned a scholarship to Oxford, got a PPE degree at Exeter College and was president of the Oxford Union – and then headed off to Harvard Business School. In 1971 he co-founded Apax Partners, Britain’s first venture-capital firm, and over three decades built up investments ranging from AOL and Waterstones to and the biotech company which cloned Dolly the Sheep.

Yet, having tried and failed to become an MP for the Liberals in the Seventies, he kindled throughout a wider interest in politics and social issues. He was an early supporter of Tony Blair when he won the Labour leadership in 1994, but the stronger bond was with Brown – for whom he helped create an initiative to promote enterprise in deprived areas. Having stepped back from a frontline role at Apax, he has spent the past few years promoting the idea of ‘social’ capital, both as a means of promoting the longer-term prospects of an Israeli-Palestinian peace deal, and to regenerate Britain’s inner cities.

Brown is clearly uncomfortable with the repeated media descriptions of Cohen as a close friend and aide. In a BBC Newsnight interview just days before becoming prime minister, he went so far as to interject at one point: ‘He is not my adviser.’ Which is true. But, as one businessman who knows both Brown and Cohen and has sat in on private meetings with them puts it, they are ‘soulmates’. Neither, he says, ‘engages in small-talk. They speak the same language. They are serious, results-focused. They go into a meeting with the attitude of “This is what we want to accomplish… here are the things we put in place.”‘

And the story of the most famous – and most dizzyingly wealthy – of London’s foreign business residents is in some ways no less Brownite. Roman Abramovich, according to the latest Sunday Times Rich List, is worth nearly £11bn, a figure that would not be out of place as a departmental settlement in Brown’s forthcoming spending review. He owns a small flotilla of yachts – and a plane: not just a lowly Gulfstream or a Learjet, but his own fully equipped Boeing 767. And Chelsea Football Club.

But it wasn’t always like that. Abramovich’s Kirkcaldy was Siberia, to which his parents had been exiled by Stalin after the Soviet occupation of Lithuania. He was orphaned, raised by his uncle and later his grandmother. He saw, and took, his chance when Mikhail Gorbachev began dismantling the state control of the Soviet economy. He scored his big breakthrough in oil – buying Sibneft, along with Boris Berezovsky, in 1995. Berezovsky is a political exile in London, frequently sounding off against Putin. Abramovich, by contrast, is on good terms with the Russian president, is still governor of a province in Siberia, and backs football and charity in Moscow – but otherwise he steers clear of politics.

He also, in ways which Brown would find familiar and reassuring, steers clear of ‘celebrity’. Ask club manager Jose Mourinho: even in his high-stake business feuds, Abramovich wields influence. He doesn’t flaunt it.

Nor do the hedgies, as a rule, though the best known of London’s rising phalanx of moneymakers can be decidedly un-Brownlike in his flashes of flamboyance. Arpad ‘Arki’ Busson spent his early twenties on the French Riviera, where he was briefly involved with the actress Farrah Fawcett. But he grew up in Switzerland, where his first job was selling toothbrushes door-to-door, and his success did not begin until, at 23, he got a job working for one of the American hedge fund giants, Paul Tudor Jones. Before long, he struck off to set up his own fund, EIM, which now controls upwards of £5bn. Busson is, by hedgie standards, at ease in the public eye. He has had to be, if only given the fact that he fathered two sons with the supermodel Elle Macpherson, from whom he has since separated, amicably.

But the hedge funds themselves resemble nothing so much as Brown’s Treasury. The principle behind them would probably have made the former chancellor’s skin crawl: the ‘hedge’ in hedge funds is from the phrase ‘hedging your bets’. They are the market equivalent of a day in the betting shop. But unlike a punt on the 11.30 at Kempton Park, their day-to-day operations are rooted in the cold calculation of financial wonkery. The idea is to spot a market – any market, from government bonds to commodities to mortgages – that is suddenly out of kilter. The ‘bet’ – sometimes for a market to rise, sometimes to fall, that doesn’t really matter to the trader – is rooted in the assumption that sooner or later the anomaly will disappear. The hedgie, and his very wealthy clients, pocket the difference.

And even Busson has his Brownite side, in the shape of ARK – Absolute Return for Kids. Along with fellow hedge funder Chris Hohn, who has separately donated £230m to a charity working to alleviate child poverty in the developing world, Busson has championed the idea that the super rich have a responsibility to help others on a super scale. Once a year, at Marlborough House on the Mall, he holds his ARK auction dinner, and raises millions.

Hundreds of hedgies attend. At this year’s gala, in May, Patrick shared a table with his boss and fellow partners – total net worth, hundreds of millions of pounds – and watched as the keynote speaker, William Jefferson Clinton, delivered the ‘perfect message for the occasion’. He joked that ordinarily he’d be a bit uncomfortable in a hall crammed to the rafters with the rich, the richer and the richest. But that what mattered was the cause, the need, to which multimillionaires directed their wealth.

Liz Hurley was there. So was Jemima Khan. And Madonna. Prince performed. But the business-end of the dinner was the annual auction – ‘rival hedgies, many of which not only compete with each other but hate each other, trying to outdo the guys at the next table’. Busson, who used the occasion to announce an £8m initiative in partnership with the Clinton Foundation to help Aids victims in Mozambique, says it’s about ‘giving something back’ – a principle he says also helped persuade him to answer the call of a fellow British hedge-fund boss, Ron Beller, to back one of the government’s city academies.

‘The charity message is genuine,’ says Patrick. ‘There are huge sums raised at the dinner, and that in the end is what matters. But it also shows the urge – in private, under the guise of charity – to be ostentatious, to pay silly money for dinner with Gwyneth Paltrow.’

And it is the ostentatiousness, however ‘private’ – and the simple, soaring scale of the wealth that has swamped London over the past decade – that is likely to ensure that the controversy surrounding the new rich will before long find its way to the top of Brown’s in-tray.

No less a figure than Sir Ronald Cohen warned in a Daily Mail interview at the height of the recent private equity furore that ‘great divergences in wealth’ carried with them the danger of a ‘violent reaction’ of the sort that erupted on the streets of Paris.

‘It’s not so much the absolute figures in themselves,’ reflects Patrick. ‘It’s the feeling of unfairness. That’s what matters in the private equity debate – a sense of disparity.’

And on a walk through Chelsea, Kensington or Belgravia on any summer morning, the ‘disparity’ with the lives of most ordinary Britons is hard to miss. ‘It’s like Monte Carlo on the Thames,’ remarks another successful hedgie. ‘The flash cars. The overdressed women. The chauffeurs…’ More acidly, a longtime Chelsea tenant protests: ‘The final straw was seeing a woman arriving for her daily croissant at Baker and Spice and lay down a cashmere blanket for her miniature poodle.’

Cohen and other wiser heads among the new rich are ‘worried’. It’s not that they expect Brown to crack down hard, if only because he is seen as unlikely to fritter away his success in allowing London to establish itself as a rival – some would say, the victor – in the contest for world financial clout. The new chancellor, Alastair Darling, seemed out to reassure them when he used his first interview, with the Financial Times, to rule out any ‘kneejerk’ changes in the tax rules.

Still, there is a growing sense that the shared interest of the new prime minister and the new rich will soon make almost inevitable a genuine change in the way the government deals with the very wealthy. The 10 per cent ‘taper’ rate is seen as likely to double to 20 per cent, a concession to controversy that the private equity bosses appear ready to live with. They also expect pressure for a new ‘transparency’ in reporting how equity deals are structured and funded. But the open question is whether there will be serious moves to get more of the super rich to pay significantly more in tax.

There is another, quite different, concern as well: that in markets and money, what goes spectacularly up is bound at some stage to go down – if not quite on the scale of the last great City boom-and-bust, which ultimately spelt the end of 18 years of Conservative government. But among the hedgefunders – smarter, older, more cautious than the Lamborghini post-adolescents of the Eighties – there are nagging doubts about the future.

‘Hedge funds are still the one legal way to go from zero to fabulously wealthy without passing go,’ quips Richard, a European hedgie who got his start in a New York bank, now runs his own successful fund and drives Formula One cars for fun. ‘The field is much, much more crowded. Every quant is looking at the same numbers. And to be really successful in the long-run, you are increasingly going to have to be one of the very big ones – with billions of dollars under management, not my $200m.’

Patrick agrees. ‘There is a feeling that it can always end. Those who have made really big money are beginning to prepare for the rest of their lives, to put something away.’ You might call it the ultimate hedgie’s hedge.

Patrick, for his part, keeps a dog-eared copy of a 2001 bestseller on his bedside table. Written by the Wall Street Journal writer Roger Lowenstein, it tells the story of the greatest American hedge fund of them all, Long-Term Capital Management. Advised by mathematicians with brains the size of Wembley stadium, including two Nobel laureates, Long-Term began making its complex bets on an array of markets in 1994. With each new profit placed on a new bet, the sums soared. So did the partners’ self-confidence, and the willingness of major banks to lend them funds to stoke an apparently failsafe money-making machine. Then came a series of ostensibly unimportant jolts, not on any of the spreadsheets or computer models – an Asian market crash, a Russian currency crisis. Long Term’s strategy was based on the classic hedge-fund assumption that, given time, the natural tendency of out-of-kilter markets to rediscover balance would have won out. But if you’re neck deep in leverage – or as the rest of us would call it, debt – time is the one commodity you can’t buy, whatever side of the wealth divide you are on.

Patrick is by no means the only hedgie to keep Lowenstein’s book close at hand. They do so not for the contents – the story of the rise and fall of Long Term is familiar to them all – but for the short, sharp, salutary message of the title. It is called: When Genius Failed.