Hedge funds ought to celebrate while they can

Date: Tuesday, March 25, 2008
Author: John Gapper, FT.com

So far so good - or at least, not too bad - seems a fair assessment of how the financial crisis has so far treated hedge funds. Although some have collapsed, including two managed by Bear Stearns, and others have hit trouble, they have generally done better than big financial institutions.

One hedge fund manager I talked to this month estimated that hedge funds with equity of about $15bn had so far been mortally wounded in an industry that now manages $2,000bn of assets. He compared this to financial institutions such as Citigroup and Merrill Lynch (and now Bear Stearns) that had suffered more.

But I do not think we have yet seen the full impact of the financial crisis on hedge funds. As banks that have kept hedge funds in business by lending them money and providing other services pull back - and it becomes much harder to leverage equity with debt - some funds will face a colder climate.

Martin Wolf, my colleague, wrote a sceptical column last week about the economics of hedge funds and how managers had perverse incentives to take risks to make big returns over a year or two before going bust. That column has produced an  indignant response on the letters page of the Financial Times today.

Christopher Fawcett, chairman of the Alternative Investment Management Association in London, agrees with the hedge fund manager with whom I talked that hedge funds have demonstrated superior risk management and investment skills to “many of the largest financial institutions”.

I think there is probably something to the idea that the top rank of hedge fund managers are better prepared to handle risks than big financial institutions and have the first pick of talented fund managers.

There are, however, signs that hedge funds are finding it harder to obtain the terms on offer in recent years, when prime brokers owned by financial institutions (including Bear Stearns) competed to grant them financing.