By Nick Evans
There is good reason for everyone in the hedge fund
community to be both optimistic and apprehensive right now
about markets and the economy, about regulation and
politics, about the state of the world at large and the
prospects for the hedge fund industry itself.
On the upside, it is clear that the industrys recovery
is gathering pace. As our new fund and asset surveys for 2010
show, hedge funds are bouncing back quickly from the upheavals
of 2008 and 2009.
Inflows are accelerating fast, from all sorts of investor
types. The environment for new fund start-ups is improving all
the time and the list of planned launches is growing by
Some of the new financial regulations coming down the line
such as the ban on bank prop trading should
breathe new life into the industry through the creation of a
number of big new hedge fund entrants. And high levels of
market and macro volatility and uncertainty should continue to
create a rich and varied opportunity set across most strategy
But there is plenty of downside risk, too and not
just at the macro event level, where the uprising in Libya and
the horrific disasters in Japan are the latest severe
escalations in a world of fast-rising instability and
Another global market crisis would have a very significant
impact on investors and there is no reason to suppose
that the money that is invested in hedge funds now would prove
to be any stickier than it was in 2008, when investors (as they
usually do) ran for the hills at precisely the wrong
But perhaps the biggest risk of all, though, is political.
And there are two areas where this is most clearly manifested
The first is in the growing chorus of rhetoric (much of it
from the banks) about the supposed risks of the shadow
banking system, by which people who use that opaque and
menacing phrase generally mean to imply hedge funds even
though hedge funds only form a very marginal part of a world
that was almost entirely the creation of the banks
And the second is in the insider-trading investigations in
the US and elsewhere, which seem to form part of a calculated
move by policy-makers to throw as much mud at the hedge fund
industry as possible at the moment in the hope that at
least some might stick. Guilt by association seems to be the
tactic and a pretty nasty one it is too.
The SEC now apparently plans to investigate all hedge funds
that consistently produce above-market returns as if
alpha per se were somehow an illegal substance. The FSA has
been getting in on the act too arresting in a blaze of
publicity a ring of alleged insider-dealers last year as part
of an inquiry that has since gone deafeningly quiet.
And pretty much everyone you meet outside the industry now
feels entitled to offer the view fuelled deliberately by
all these so far unproven regulatory actions and insinuations
that hedge funds only make money by systematically
rigging markets and trading on privileged or inside
Kill the bad hedge funds and regulate the rest.
That was reputed to be the US Treasurys attitude under
former Goldman banker Hank Paulson in the depths of the crisis
in 2008, as revealed in emails between senior Lehman management
at the time.
How real that supposed strategy seems now and how
depressingly typical it should be that the banks themselves are
now rallying to the cause, doing their best to fuel unease
about the all but non-existent systemic risk posed by hedge
funds and to shift the focus away from their own intrinsic and
largely unresolved structural and cultural flaws.
Quite why anyone should ever be forced to listen to a banker
again on the subject of risk is a mystery. It was they who blew
the roof off last time not hedge funds. It was they who
nearly bankrupted most major governments not hedge
funds. And it will be they who cause the next financial crisis
too you can bank on it.
So the industrys increased influence and visibility
may have good and bad consequences. Investors are clearly keen
to put more and more money into hedge funds. But supervisors
are clearly keen to exercise more and more control.
The future for hedge funds should be very bright as
long as regulators do not fall either for the self-interested
posturing of the banks, or for the ignorant twaddle of the
But thats a big if. Right now you wouldnt want
to bet on the outcome. That growing light in the tunnel may yet
be an oncoming train.