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Hedge-Fund Bubble Bursts in Time for Swine Flu

Date: Wednesday, April 29, 2009
Author: William Pesek, Bloomberg

Swine flu marks the bursting of yet another bubble.

The latest airy hope to be deflated is over the worldís ability to withstand the occasional pandemic risk. We did it with SARS in 2003 and avian influenza in 2005. That was before swine flu and the World Health Organizationís declaration that it isnít containable. Forget surgical marks. Gas masks, anyone?

The question now is whether this disease will morph into an international disaster that will devastate markets.

Asiaís future is also affected by the bursting of a second bubble: hedge funds. Almost 20 percent of Asia-Pacific hedge funds closed in the 15 months to March, with that rate set to accelerate in todayís dire economic conditions, according to London-based magazine AsiaHedge. If swine flu really is the Big One, the effects of these two bubbles will converge, dragging down asset prices and deepening the recession.

Markets didnít need this challenge. Thereís something almost biblical about whatís happening around the world. Really, whatís next? A plague of locusts? Raining frogs? The fragility of the global economy raises expectations for how public officials will handle swine flu. Any hint of incompetence will hurt markets early and often.

Two Bubbles Popping

All this spells trouble for the worldís most-populous region. This is also the most economically promising area, one on which corporate executives in New York, London and Johannesburg are depending for future growth and profits.

Asia, with its teeming populations, crowded cities, high poverty and spotty access to health care, must be considered a future hot zone. Thatís why even though Mexico is the epicenter, Asian governments are moving fast to prepare for outbreaks. The regionís vulnerability will grow exponentially over time.

Even without swine flu, economies arenít close to bottoming. The best-case scenario is for growth to level off at very low levels. Stimulus packages of about $2 trillion globally arenít enough to offset the wealth destruction of the past 18 months. Mark Matthews, a strategist at Fox-Pitt Kelton in Hong Kong, puts the loss in equities alone at $30 trillion.

The credit crisis caused the shuttering of 129 Asia-region hedge funds in 2008. Thatís the most in at least eight years and more than double the number in 2007. An additional 17 closed funds in the first quarter.

Fund Closures

Hedge funds around the world are reeling after losing 19 percent on average last year and investors withdrew $155 billion, the worst performance since Chicago-based Hedge Fund Research Inc. began keeping records. Investor redemptions have soared since Lehman Brothers Holdings Inc. folded in September.

The health of Asiaís hedge funds is less interesting than the forces that drove the industryís growth. At the end of 2008, there were about 930 Asia-region hedge funds, according to AsiaHedge editor Paul Storey. In 2000, there were about 160 Asia hedge funds. It was always a bubble waiting to explode.

At the time, investors said the sudden rush to start hedge funds in Hong Kong, Japan and Singapore reflected Asiaís maturity. That was true to an extent. It was more about Asiaís rapid growth and its underdeveloped markets. The region was rife with the inefficiencies that speculators exploit. For anyone aiming to profit from disparities in the prices of similar bonds or other assets, Asia was an obvious place.

Bandwagon Effect

Then there was the bandwagon effect. There were suddenly too many aggressive investors pursuing similar strategies, thus cannibalizing the benefits. And when markets were booming in the mid-2000s, lots of people who went to work at hedge funds had little hands-on experience. ďIf he can get rich, so can IĒ was the dynamic that pervaded the industry.

Some good may come of the current shakeout. Kirby Daley, a senior strategist at Newedge Group in Hong Kong, says the managers who survive will represent an industry that is stronger and more diverse in strategy. Still, itís impossible to say at this moment how many will be left.

Swine flu deepens the plot. Itís a big concern that health officials are giving up on containment already. They are focused on treating patients and strengthening preparations for outbreaks. The WHO raised its global pandemic alert to the highest since the warning system was adopted in 2005.

Asian markets plunged during the 2002-2003 outbreak of severe acute respiratory syndrome. SARS killed 770 people, a number that belies the hysteria that swept the region. In reality, SARS was the health equivalent of the Y2K computer bug in 1999. And yet it took a toll on Asiaís economies and markets.

Swine-flu concerns may also turn out to be overdone. If not, expect markets in Asia to be in for an even rougher 2009 than seemed possible just a couple of weeks ago. And expect more hedge funds to go bust.

(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: William Pesek in Tokyo at wpesek@bloomberg.net