Bearing the Brunt

It’s not just the banks that have taken a hammering recently, hedge funds have had more than their fair share too. Tainted by Madoff’s high profile Ponzi scheme and used as a scapegoat for much of the recent market turmoil, hedge fund managers must have been thinking that it couldn’t get any worse.  That was until the recent Treasury Select Committee Banking Enquiry where they were described as an “opaque bunch of spivs gambling with public money.” This was a step too far. Yes, investors have suffered losses as a result of hedge fund failures, yes even the industry accepts the need for greater regulation, but opaque gamblers of public money hedge funds are not.

Moreover, what the hedge fund critiques have forgotten is how many hedge funds themselves have been the victims, rather than the cause of market turmoil.  For example, the high profile collapse of Lehman Brothers meant that heavy losses were incurred by funds forced to unwind their positions with their prime broker in falling markets.  And those were the lucky ones, it was widely reported that some high profile London-based hedge fund managers, even had their Lehman balances frozen.  It doesn’t take a genius to work out who the victims were here.

So what next for an industry which has borne the brunt of so much of the current market malaise?  The priority right now is for hedge funds to restore investor confidence.  Addressing counterparty risk management is one of the main routes to achieving this and hedge funds are taking this issue very seriously.  A recent Aite Group report on the hedge fund industry found that counterparty risk has become a critical business issue for hedge funds and the key factor in deciding prime broker relationships.  It has become such an important issue that more than half of the hedge funds surveyed said that they monitored counterparty risk on a daily basis -  managing collateral and reconciling positions is one of the main routes to achieving that goal.

Having said all of this, it is not just addressing counterparty risk that will instil investor confidence; all types of risk need to be considered – operational ,market, and systemic risk.  In particular, we are seeing some risk-astute hedge funds placing much of their focus on augmenting their operational infrastructure and infact, in many cases, operational/risk issues are being referred to before trading decisions are being made.  Many would argue that these types of risk management constraints stymie the ability of hedge funds to make money, but without them, it will be impossible to attract the institutional money which, prior to the market turmoil, was beginning to flow into the sector.

Thanks to the events of the last six months, there is no doubt that hedge funds need to re-evaluate all strands of their risk management procedures.  Failure to do so, will stem the flow of investment into an industry which is already floundering.  With this in mind, the industry should be left to get on with addressing these issues rather than being forced to defend itself against wild or misleading public accusations.