Report Predicts Bloodletting For Global Hedge Fund Industry

by Carla Johnson, Investors Offshore.com

20 May 2005

After two years of phenomenal growth for the industry, a recent study by the Centre for Economics and Business Research has predicted that the next two years will see a certain amount of blood-letting in the hedge fund world, as the recent drop in returns forces many firms out of business.

According to the CEBR, after an "awful" first quarter, hedge funds are now 8% poorer than they were at the beginning of the year. Although May could herald a turnaround in hedge fund returns, performance is likely to remain muted over the short to medium term, a fact that could force out as many as 1,600 of the estimated 8,000 hedge funds worldwide.

Moreover, the worsening conditions are likely to decrease the rate at which new hedge fund firms are entering the market.

Noting the words of US Federal Reserve Vice Chairman Roger Ferguson, who said last week that hedge funds do not pose a major risk to global financial stability following rumours that many large funds had incurred heavy losses on the debt of Ford and General Motors, the CEBR contends that the cumulative effect of widespread hedge fund failures is likely to keep interest rates lower than is generally expected over the next couple of years.

The report also warned that hedge fund managers are allowed to take on too much risk in order to earn a profit, and more importantly, a bonus.

"The tendency for hedge funds to take on excessive risk is exacerbated by reward structures for managers that are asymmetric - there is heavy gearing on high returns, while if a loss is made, the manager merely fails to collect a bonus."

The report quipped: "For investors looking for high risk high yield investments, may we recommend horseracing?"

The CEBR estimated the number of hedge funds has grown from 2,000 in 1990 to 8,000 in 2004, managing assets of $1.1 trillion.

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