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Gloomy Forecast On Hedge Funds

Date: Saturday, October 25, 2008
Author: Kevin Sullivan and Neil Irwin, Washington Post Foreign Service

LONDON, Oct. 24 -- The hedge fund industry, a once-unstoppable profit machine that has already lost more than $200 billion in value this year, could shrink by a quarter or more as the global financial crisis deepens, according to industry analysts and fund managers.

Meanwhile, investors, typically giant institutions and wealthy individuals, are pulling money out of many money-losing hedge funds. That, in turn, appears to be contributing to the wild swings in markets, analysts say, as these redemptions force the funds to sell stocks and other assets, and unwind other complex investments in ways that can effectively drive up prices.

Officials speaking at Hedge 2008, an industry gathering in London, said this week that a quarter to a third of hedge funds could go out of business in coming months as markets sink, credit dries up and investors withdraw their money.

"In a fairly Darwinian manner, many hedge funds will simply disappear," said Manny Roman, co-chief executive of the New York-based GLG Partners.

Although hedge funds have not been a significant cause of the financial crisis, the events of recent weeks are leading regulators around the world to lean toward more extensive oversight of the industry, which has $1.7 trillion in assets under management. Momentum toward regulation is also building in Washington.

"Hedge funds can be major forces in the global financial markets, but very little is known about how they operate and the types of systemic risks they may generate," said Rep. Henry A. Waxman (D-Calif.), chairman of the House Oversight Committee. "The question we will be asking is whether this is an area where more transparency and oversight would be beneficial to the markets."

Hedge funds use a wide range of investment strategies to try to get high returns for investors; some simply pick which stocks they think will do best, while others have highly complex strategies based on trading futures, options, currencies, debt products or commodities.

Regulators at the Federal Reserve, Securities and Exchange Commission and beyond have increasingly concluded that they need more power to gather information about what kinds of risks hedge funds are taking and what risks they pose to the financial system as a whole.

Using its existing legal authority, the SEC attempted to require hedge funds to register as investment advisers, but a court ruled against that decision in 2006. In congressional testimony Thursday, SEC Chairman Christopher Cox said the agency wants lawmakers to grant it that authority explicitly. He also said he would favor folding the Commodity Futures Trading Commission, an independent agency that regulates futures markets, into the SEC to better coordinate regulation.

Leaders of the Federal Reserve, meanwhile, are broadly re-examining their views on financial regulation in light of the crisis. Among their concerns is that light regulation could be worse than none at all, as it could give hedge funds the implicit protection of government oversight even if officials lack the tools to actually guard against risks to the system.

British Prime Minister Gordon Brown has pressed for greater global regulation of financial markets and has said he will press for such at a meeting of world leaders in the United States on Nov. 15. He has not detailed any new regulations specifically aimed at hedge funds.

At the London conference, the atmosphere was gloomy, as an industry that relied on easy credit to make big bets with borrowed money during the boom years adjusts to a new reality.

Mamoun Tazi, an analyst at MF Global Securities in London, predicted that the global hedge fund industry, based largely in London and New York, could see its assets cut by 25 percent in the coming months.

That record contraction would have a deep impact on a broad range of private investors, government and corporate pension funds, insurance companies, banks, and other financial institutions that have relied on hedge funds as a lucrative way to diversity their portfolios, Tazi said.

Others predicted less dramatic losses and said hedge funds had so far weathered the global crisis better than the world's financial markets as a whole.

"We are doing less bad than everybody else," said Antonio Borges, chairman of the Hedge Fund Standards Board, a private group of fund managers and investors based in London.

Hedge Fund Research, a Chicago-based analysis firm, said the global industry includes about 10,000 funds. The firm said that so far this year 487 new ones have been launched and 350 have been liquidated.

Those gathered in London had mixed views on greater regulation. Roman, the executive at GLG Partners, said greater regulation of hedge funds was "long overdue." He said "someone can graduate from college on a Friday and start a hedge fund on Monday."

But Borges said the current political clamor for more regulation could backfire and hurt the economy. "We are not saying that we need zero regulation," he said. "We just need better regulation."

Many seemed to relish the fact that the financial crisis has its roots not in their industry, but in the much more heavily regulated banks, investment banks and insurance companies.

"Contrary to the expectations of some commentators . . . hedge funds were not the catalyst or driver of last summer's market events that we are continuing to witness," said Hector Sants, chief executive of Britain's Financial Services Authority.

Irwin reported from Washington. Staff writers Amit Paley and David Cho in Washington and special correspondent Karla Adam in London contributed to this report.