Hedge Fund Street

Hedge Funds: See Saw Industry

Back in 2003, this was a US $500 billion industry and in just three years, we are talking in trillions. Now, here are a few statistics I have managed to get off the web. They’ll show you how big hedge funds have become today.

• On an average day, between 18 and 22 percent of all trading on the New York Stock Exchange is hedge fund related.
• And between 30 to 35 percent of all trading on the London Stock Exchange is hedge fund related.

Something isn’t it? But that doesn’t mean there are no downfalls. This industry is famed for its enormous losses as much as it is for its legendary gains. Recently, the Ohio Bureau of Worker's Compensation lost $215 million in a hedge fund that only invested in U.S. Treasury securities! And the worst part: the Bureau of Worker's Compensation had only invested a total of $225 million in the fund in the first place, so their loss was to the tune of 95 percent of their total investment!

But such is life in the fast lane of the world's financial markets. You can always expect the unexpected. Things have occurred in the financial markets that nobody could have ever anticipated, but managed to happen anyway. Ultimately, the markets always have a way of showing even the best and the brightest that they are nowhere as smart as they sometimes think they are. However, the best thing about this industry is that you can never be bored with hedge funds. That’s because you are always anticipating something to occur and not knowing if it will happen or if things will take a turn for the unexpected.

Domesticating the hedge fund market

A recent study conducted by consultants Mercer Oliver Wyman shows that hedge funds have substantially improved their risk management practices in recent years to reduce threats to the financial system and investor losses from fund failure. Wow, now that’s something for an industry that began life as a reckless, wild thing that made immense profits and bigger losses. Sounds like they’ve let go of the fun to make consistent returns.

As per the Mercer study, hedge fund managers and banks that service the industry have made substantive strides in many dimensions of their risk management practices. The study also found an interesting aspect in the working method of hedge funds. According to the study, large established hedge funds make extensive use of sophisticated stress-tests and scenario planning. This is done to offset the likelihood of being forced to liquidate positions in an unplanned or untimely manner. Such an event could threaten market stability and lead to a structural collapse.

Regulation is still the flavor of the season

I know this is getting a bit frayed, but since it is the hot topic of the day, I have no option but to report on the latest happenings on the regulation front. Securities and Exchange Commission chairman Christopher Cox feels that hedge fund regulation is inadequate" and that Congress may need to demand more oversight of the $1.2 trillion industry. Boston.com reports:

Regulators are becoming more concerned about hedge funds because of the power they wield in financial markets and the growing number of frauds. As the industry's assets doubled in the past five years, funds including Bayou Group, Manhattan Investment Fund, Lancer Group, and Philadelphia Alternative Asset Management collapsed, saddling investors with losses.

Read more: SEC chief calls hedge fund rules `inadequate'

Hedge funds make millions as UK McCarthy & Stone bid war intensifies

Hedge funds seem poised for gains after a bidding battle for U.K. retirement homebuilder McCarthy & Stone PLC intensified recently. If a recommended 1,000-pence-per-share offer from private equity firms Barclays Capital PIA and Permira Advisers goes through, several hedge funds that bought shares in the builder for as little as 872 pence in recent weeks will make millions on their holdings. Easybourse.com reports:

Losses are also possible, though. Some hedge funds have paid as much as 1,045 pence per share in recent days in a bet a buyout of the company will come at a higher price than current proposals.

Read more: Hedge Funds Benefit From UK McCarthy & Stone Bid War

Do hedge funds need regulation?

And the debate continues. I have been writing on and off about how the authorities felt the need to regulate hedge funds. You know what, it makes me think? These hedge funds are like the goose that laid golden eggs and the authorities are not the greedy farmer, but just a misguided old man who does not know a golden egg when he sees one.

Last month, the U.S. Court of Appeals struck down a new rule by the Securities and Exchange Commission requiring mandatory registration with the SEC for most hedge funds. Many people believe that registration for hedge funds is a good thing. I mean when an investment pool that contains over $1 trillion in investments, you cannot let it function as it pleases. And that argument is right to some extent. I mean, hedge funds make high-risk bets and sometimes, if they collapse, they can take much of the world markets with them. Courierpostonline.com reports:

This is the third time in less than a year the appeals court has blocked the SEC from acting beyond its authority. According to The Washington Post, "Former SEC member Harvey J. Goldschmid, who voted to approve the plan, yesterday urged regulators to appeal to the U.S. Supreme Court, members of Congress or both. In the Pequot case, a former SEC lawyer who worked on the Pequot investigation before being fired by the agency has written a letter to key members of the Senate banking and finance committees alleging that the SEC dropped the probe because of political pressure."

Read more: Hedge funds must be regulated

Hearing on hedge funds

The U.S. Senate Banking Committee plans to hold a hearing on July 25 to discuss the regulation of hedge funds. This is probably in response to a bill that was introduced in the House of Representatives to revive efforts to tighten government oversight of the hedge fund industry. Reuters.com reports:

A federal appeals court last month threw out an SEC rule adopted in 2004 that required most U.S. hedge fund advisers to register with the investor protection agency and submit to occasional inspections.

Read more: U.S. Senate committee sets hearing on hedge funds

How hedge funds turned the tide

It’s no news that pension funds are now increasingly looking to hedge funds to increase their investment returns. What is interesting is traditionally cautious pension funds are changing their portfolios to increase their allocation range for hedge funds. This means, they have seen the returns that hedge funds can offer them not just once or twice but over a period. And the best part is that these returns are consistently high. Much higher than what stock or bonds can offer. Add to this the fact that hedge funds have become more stable and don’t take too much risk, and you have a winning equation for pension funds.

Take for example CalPERS, the largest pension fund in the United States, which has over $210 billion worth of stock, bonds, funds, and private equity. It is now expanding its investment strategy into hedge fund managers. The fund also increased the target allocation range for hedge funds significantly, to as much as 5% of the plan’s global equities portfolio.

Until recently, funds like CalPERS invested more than 70 percent of their assets with long-short equity managers. Initially it was a good idea as hedge funds in their earlier form were volatile by nature. Returns could be very high or there could be huge losses. Compared to this, the equity market was quite stable. Of course, the returns were not phenomenal but they were consistent and that was what mattered.

However, of late hedge funds now ensure that they afford their clients with the benefit of consistency along with their high returns. And now that traditional strategies, such as equity long-short, become more crowded, the returns get diminished. All this goes to benefit the hedge fund market that increases its customer base and gets more respectability in the bargain.

Hedge fund database InvestorForce to be bought over by Morningstar

In a deal that will create the largest and most comprehensive investment databases available, Morningstar plans to take over the institutional hedge fund database of InvestorForce, a US-based financial software company. Morningstar is expected to pay up to $10 million for the new database, which is used by pension consultants among others in managing clients' investments. Bobsguide.com reports:

The transaction will net Morningstar more than 450 customers in the form of institutional consultants, private and institutional investors and asset managers.

Read more: Morningstar to buy hedge fund database

Are hedge funds getting to be boring and predictable?

Common belief is that hedge funds are supposed to make money the risky way so why is it that hedge fund managers are now fighting shy of taking risks? Their argument is that their customers don’t want them to deal in such investments. So, for fear of losing these customers and more importantly, their fees, which can only be called exorbitant, hedge fund firms are now learning to play safe.

This sudden change in what is essentially a risk-taking business came about slowly. The sector's profile witnessed a change after institutions poured money in and drove worldwide hedge fund assets to more than $1,000bn. This large amount of money has weighed heavily on hedge fund performance and has led to ‘overcrowding’ in many strategies. As they reach critical mass, these firms begin to slowdown their aggressive activity and try to appease their major clients.

Hedge Fund’s purchase of shares spurs Rite Aid rise

Shares of drugstore chain Rite Aid Corp. rose in midday trading on Monday after hedge fund Tudor Investments disclosed it has been buying up shares. This information has spurred investor speculation about a restructuring, a recapitalization or a sale of the company. Chron.com reports:

The market often follows the lead of hedge funds because investors see hedge funds as smart money. Also, hedge funds often buy large positions in companies and angle for change to goose share prices. Tudor's acquisition of Rite Aid shares may be leading investors to speculate about mergers, restructuring or another technique hedge funds typically demand to boost stock prices.

Read more: Rite Aid Rises As Hedge Fund Buys Shares

Morningstar Inc provides fee and return data on the hedge fund industry

The key to making less financially fatal errors is by self education. The reference being made specifically here is in regard to the Hedge Fund market. The need for self education has grown manifold in today’s unregulated scenario. As more and more Hedge funds are coming downstream and trying to appeal to Middle America and investors the need for investors to be well informed has never been more.

A Chicago-based research firm, Morningstar Inc., which is best known for its mutual-fund ratings, has now started providing fee and return data on 3,000 hedge funds. Morningstar's managing director, Don Phillips, stated that with average American putting his money in hedge funds, the industry simply cannot operate in secrecy and hence the need for this information.

It may be recalled that according to Hedge Fund Research Inc. of Chicago, there are about 8,800 hedge funds worldwide today with at least $1.2 trillion in assets.

Unregulated Hedge Funds – does the market need a ‘regulator’

The hedge fund industry is well over the $1 trillion mark and growing. The Chicago-based Hedge Fund Research Inc.'s data finds that there are nearly 9,000 hedge funds in the market today. With so much money under circulation, what the industry needs most is some policing. However after the court overturned the U.S. Securities and Exchange Commission’s rule that had taken effect on Feb 1st, the whole market is back to its own ways.

Today hedge funds have become such popular investment tools that everyone from pension funds to 401(k) plans to endowments uses them to potentially boost their returns. So the hedge funds are not just for the rich any more. This puts the investors, who are technically not very risk friendly, to face the kind of risk that they should not be taking.  A Long Term Capital Management and Bayou Group fund collapse today is likely to cause more damage than ever where the retiring population stands to loose a substantial amount of their savings that is their only means to living. Is it therefore wise to let the industry grow un-policed and un-regulated? Read more on this in the article on the need to police hedge funds.