April 19, 2006
‘Hedge funds are dangerous investments’
Hedge funds have suddenly become the rage all over. What was considered a risky adventure fit for those moneyed few has suddenly become one of the best methods of making money. And this has led to an explosive growth of this once reviled method of investment. Today the mounting integration of hedge funds into the world financial system has made most industry experts and even central bank policy-makers wary. They believe that hedge funds have increased the risks in the industry and need to be minutely scrutinized.
Sounds more like a doomsday warning. While on the one hand, the Nobel Foundation granted this industry a lot of credibility by investing some of its funds into the hedge fund market, there are others who believe that the growth of hedge funds could have serious implications. At a recent conference hosted by the Federal Reserve Bank of Atlanta on systemic risk, senior policy-makers believed that the unregulated activities of hedge funds could lead to serious problems. What is it that is worrying these financial gurus?
Most policy makers believe that these unregulated funds could, at some point in the future, cause a crisis, which could spill over into the real economy and damage its goals of low inflation and sustainable growth. According to them, the problem with hedge funds is that they use strategies, such as short selling and derivatives trading. This differs vastly from the strategies used by traditional equity and bond funds. To be honest, I don’t see a problem with being different.
Another problem according to experts is the increasing involvement of pension funds in this industry. According to statistics, the volume of investment made in hedge funds by pension funds has more than tripled. Pension funds have traditionally relied on much safer, and lower yielding, investments. All this noise about their lack of reliability has made the U.S. Treasury watch the hedge fund industry closely. And one of the outcomes of this close watch is that now, many hedge funds are required to register with the Securities and Exchange Commission.
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