Sometimes financiers get it right and perform a valuable public service

The world of high finance sounds rather like a zoo. It's not only the bulls and bears of the stock market, or the hawks and doves that flock around the central banks.

Investment banks are "vampire squids". Hedge funds are "locusts", speculating against decent companies and entire countries until they collapse into bankruptcy.

Jordan Belfort, the drug-addled conman who pushed dodgy stocks of hopeless companies on poor Americans in the 1990s, styled himself as the "Wolf of Wall Street".

And there is, sadly, a lot of truth in such stereotypes. Finance is often parasitic on the real economy and predatory in its behaviour towards clients and customers.

But critics and reformers should also recognise when some financiers do not conform to this negative characterisation; and to acknowledge when the industry performs a broad public service.

The first people who recognised that something was financially awry at the giant outsourcing firm Carillion were not regulators. They weren't civil servants. They certainly weren't the company's auditors. Nor were they the firms' bankers or passive asset managers, who invested in Carillion on behalf of pension funds and insurance companies.

It was hedge funds. Their research on the company revealed that Carillion was paying its suppliers very late - a classic sign of possible financial distress. They also noticed that Carillion was piling up large amounts of off-balance sheet debt. Hedge funds such as Marshall Wace and CapeView Capital started taking substantial short positions in Carillion (betting on the share price falling) as early as 2013. If only ministers, who continued bunging large public contracts to the firm right up until its demise, had been similarly on the ball.

The hedge funds didn't kill Carillion - its incompetent management did that. The hedge funds were effectively sounding a warning, albeit one that wasn't heeded by enough people.

The classic image of "sell-side" analysts working for stockbrokers and investment banks is that they are hopelessly compromised, tailoring their views on the prospects of firms to please their existing (or potential future) corporate clients, rather than to serve the interests of actual investors.

It's often true - but not always. Two years ago another outsourcer, Capita, was riding high in the stock market, its share price at £ 11, and was widely approved of across the City. But one analyst at the stockbroker Panmure Gordon, Michael Donnelly, broke with the consensus and cautioned clients about the sustainability of the business based on his own reading of the company's data. Last week Capita's share price fell below £ 2 and the new chief executive admitted that the company had, in fact, been appallingly run for years. Donnelly's warning was vindicated.

Purple Bricks is one of the new breed of online estate agents. Managers have claimed they successfully sell around 90 per cent of the properties they handle within 10 months - a comfortingly high proportion for homeowners thinking of paying the roughly £ 1,000 flat up-front fee for its services. But Anthony Codling, an analyst for the investment bank Jefferies, said in a note last week that his own research (ploughing through Land Registry data) suggested Purple Bricks is actually only selling around half of the properties on its books in that time, which is in line with the rest of the estate agent industry. The share price of the company, which is in the midst of an international expansion, sank in response.

Purple Bricks has rejected Jefferies' data, although it hasn't released their own to rebut it. But the point here is not the truth of any particular view on a company's finances or growth prospects, but one pertaining to the kind of behaviour we want from asset managers and financial analysts. These are instances of financiers ignoring the rubber stamps of auditors, brushing aside the confident assertions of company executives, going against the herd, and performing their own, original, research.

This is also what the small band of hedge fund managers profiled in Michael Lewis' The Big Short did with regard to US "sub-prime" mortgage loans that fuelled the disastrous international credit bubble before 2008.

The economist John Kay, who wrote an official review of equity markets for the Government in 2012, recommended that asset managers should have deep knowledge of and regular engagement with the managements of the companies in which they invest. This will involve digging out inconvenient facts.

"Obtaining better information about companies is essential to the efficiency of markets and society," he says.

The many critics of finance are quite right. The sector unquestionably needs wholesale reform. The wolves and vampire squids must be defanged. But high finance is not going to disappear, at least not while ordinary people have savings and pensions that they want to be invested in decent companies with reasonable growth prospects.

As well as getting justly angry at finance's many abuses, we need to have a vision of what we want the sector to be and the socially useful job we ultimately want financiers to perform. The past month has given us some signposts.

Think you're too savvy to put your savings in a rip-off hedge fund? Think again

"Um, hello - can I tell you about the real world?" Those were the words of a remarkably self-confident Scottish hedge fund manager, Hugh Hendry, on BBC's Newsnight in 2010. He was addressing the Nobel laureate economist Joseph Stiglitz in a memorable debate about Greece.

The spicy and combative Hendry made for great television. He was invited back onto the show. Indeed, Hendry went on to appear on Question Time, where he airily cut off the then-deputy Scottish first minister, Nicola Sturgeon, with the words: "I know what I'm talking about, Nicola."

The loquacious Hendry became something of a media personality for a period; the face of the UK hedge fund industry. But now, seven years on, the real world has told Hugh Hendry something. Last week he announced the closure of his hedge fund Eclectica, after haemorrhaging investors' money. It may have something to do with the fact that last year Hendry was apparently betting on a break-up of the entire European Union.

Hedge funds are investment pots, which claim to deliver superior returns to ordinary managed funds due to the intellectual brilliance of their managers. Often - and certainly in the case of Hendry's fund - the strategy is to take large, counterintuitive bets on the direction of markets: bets that ordinary fund managers don't have the courage or the freedom to make.

Sometimes these bets pay off and the rewards are spectacular. Often they don't. And as a group, hedge funds have delivered miserable results in recent years, registering lower returns, on average, than funds that simply passively track the major stock markets. Not much evidence of brilliant minds there. And those average returns for the sector have probably been upwardly biased by "survivorship bias". This means closed-down funds like Hendry's simply fall out of the various indexes of the hedge fund sector, flattering its overall recorded performance.

This matters. In 2016, more hedge funds closed than in any year since the financial crisis. Some 260 hedge funds were shut in the first quarter of 2017 alone - almost 3 per cent of the 10,000 total.

But running a failing hedge fund can still be very profitable for the fund managers themselves. Their traditional "two and 20" fee-charging formula (where they cream off 2 per cent of all assets under management every year, plus 20 per cent of any capital growth) means any investment success they achieve over an extended period ends up profiting the manager far more than the investor.

Of course, as we've seen, a great many funds never survive for an extended period. They simply shut up shop when they lose money after making a big bet that goes wrong. But 2 per cent of, say, a £50m seed investment is still £1m. Get a lucky run for only a few years, and a manager can accumulate an impressive fortune. No wonder hundreds of new funds open every year.

The media focus in relation to hedge funds tends to be on the potential risks they pose to financial stability.

Could they blow up the system like banks did in 2008? That's not entirely misplaced, given the size to which they could grow and the influence some of the larger ones can have on specific markets. Yet the greater risk from hedge funds is to the money of those who are naïve enough to invest in them.

So given the obviously poor returns of hedge funds, are investors yanking their money out of the sector en masse? Not exactly. Today there is around $3 trillion (£2.1) trillion of money worldwide invested in hedge funds - almost double the amount of seven years ago. Even when returns have been awful, the cash has continued to flow in. Some of that money will belong to naïve rich people. But a large and increasing share, according to UK regulators, now comes from ordinary pension schemes, as their stewards seek to juice-up their overall results through an allocation of part of their money to "alternative" asset classes.

A report last year from SCM Direct estimated that 4.8 million people in the UK are invested in hedge funds through their pension schemes. The Tesco pension scheme has around £738m in hedge funds, while Lloyds Bank's has a £1.9bn allocation. The West Midlands local authority pension scheme had £226m in such funds; West Yorkshire £259m. And so on. The vast majority of the ultimate beneficiaries of these schemes are likely to have no idea that they are exposed to hedge funds and their awful returns and rip-off fees.

A tiny number of hedge funds do deliver market-beating returns over a long period. But the vast majority don't. Investing in them is, generally, a terrible idea. It's an approach overwhelmingly likely to enrich people like Hendry and leave you personally worse off. But the people who look after your retirement savings are doing it anyway.

That's the "real world" of investment with other people's money. And it's certainly not the one Hugh Hendry was introducing us to seven years ago.