EU backs tougher rules for hedge funds, private equity

EU backs tougher rules for hedge funds, private equity


European Union finance ministers backed stricter rules for hedge funds and private equity groups on Tuesday.

Reuters
Published: 4:36PM BST 18 May 2010

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European Union finance ministers backed stricter rules for hedge funds and private equity groups on Tuesday. German Finance Minister Wolfgang Schaeuble answers questions. Photo: AFP

The draft rules will control pay and borrowing at hedge funds as well forcing them to disclose extensive information about how they are investing or short-selling.

The strict regime is part of a wider set of pledges by world leaders to create a more stable financial system.

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"We are determined to accelerate the pace of regulation," Wolfgang Schaeuble, Germany's finance minister, said after the meeting.

"Up until now this was not regulated," he said of the hedge fund and private equity industry. "This hole will now be closed."

Britain had fought to water down the law and was hoping to overturn a provision that refuses to grant a single licence for foreign funds to do business across Europe. US Treasury Secretary Timothy Geithner has also objected to this.

London's objections were overruled in rare break with Brussels diplomacy which says no country should accept a law that it does not want to.

British diplomats said they had achieved the "best possible" outcome from the meeting, but concerns remain about the impact tighter regulations will have on London's hedge fund industry.

Britain is home to 80pc of the bloc's hedge funds and believes the new rules - likely to take effect around 2012 - will curb choice for investors by making it harder for managers to find investors across the EU's 27 countries.

Only the Czech Republic backed Britain in opposing the approval of the new rules by the finance ministers, insufficent support in the face of heavyweights France and Germany, who pushed for rigid restrictions.

The vote left Britain's new finance minister, George Osborne, outvoted at his first meeting with his peers. Officials said he did not speak during the deliberations on the issue.

The European Parliament's economic affairs committee approved its version of the draft measure on Monday evening, opening the door to formal negotiations on a final deal with EU states, perhaps by July.

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/ditch-the-directive/7737229/EU-backs-tougher-rules-for-hedge-funds-private-equity.html

Hedge fund selling hits 18-month high

Hedge fund selling hits 18-month high


Hedge funds have embarked on their largest selling spree in a year and a half as market uncertainty drives many investors to sell shares as fears over the stability of many Western economies grow.

By Harry Wilson, Financial Services Correspondent
Published: 5:47PM BST 19 May 2010

In a sign of the speed with which market sentiment has deteriorated over the last month, hedge funds have made a dramatic switch from their biggest buying spree in more than two years to become big sellers once again, according to UBS.

The latest data from UBS's prime brokerage business, which handles the Swiss bank's dealings with hedge funds, shows that as of the end of last week selling by funds was at its highest monthly level since January 2009.

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Hedge funds have been blamed for much of the recent volatility in world markets, with the German government prompting chaos on Wednesday with its ban on short-selling in the shares of 10 major Germany financial institutions, including Allianz, Commerzbank and Deutsche Bank.

Based on the UBS data, hedge fund selling of bank shares has been relatively muted, with most of the net selling focused around the IT, consumer services and transport, telecoms, and metals and mining sectors.

From heavy selling earlier in the year, hedge fund and long-only investors' buying of bank shares has picked up in the last two months, leading some to question why the German government decided to institute its ban now.

Pedro de Noronha, managing partner of hedge fund firm Noster Capital, said the ban was "ridiculous".

"All it proves is how scary it is to have people who are unsophisticated in financial markets imposing regulations on products they don't understand," said Mr de Noronha.

To compound the sense of victimisation felt by hedge funds, the announcement of the ban came on the same day that European Union finance ministers voted through tough new industry regulations in a move widely seen as more political grand standing than considered law making.

The Alternative Investment Fund Managers directives will put hedge funds under a new super-regulator for the first time, despite repeated criticism from industry trade bodies.

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/7741612/Hedge-fund-selling-hits-18-month-high.html

The Role of Hedge Funds in Financial Crise

The Role of Hedge Funds in Financial Crises – Stephen Brown 

On October 2, the U.S. House Oversight and Government Reform Committeeannounced a Hearing on Regulation of Hedge Funds scheduled for Thursday, November 13, 2008. The focus is on the causes and impacts of the financial crisis on Wall Street, and the Committee will hear from hedge fund managers who have earned over $1 Billion.

The underlying premise of these hearings was expressed by Dr. Mahathir Bin Mohamad, the former Prime Minister of Malaysia, who wrote on September 26 “Because of the extraordinary greed of American financiers and businessmen, they invent all kinds of ways to make huge sums of money. We cannot forget how in 1997-98 American hedge funds destroyed the economies of poor countries by manipulating their national currencies”. The Prime Minister is recognized as an authority on the role of hedge funds in financial crises, given his experience managing the Asian currency crisis as it engulfed his nation in September eleven years ago. He is particularly critical of the role of George Soros who will in fact be invited to testify before the House Committee at their November hearing.

It is perhaps too early to write about the causes and consequences of the current financial crisis while the storm still rages. However, it is not too early to examine the history of the earlier financial crisis. During the 1990s, according to the International Monetary Fund, financial intermediaries had been investing steadily into South East Asia. There was a net inflow of about US$20 billion into the region over and above portfolio and direct investment, up until 1995 and 1996 when the amount increased dramatically to US$45 billion per annum. Then with the collapse in both the Baht and the Ringgit in 1997, there was a sudden outflow of US$58 billion. It was self-evident to the central bankers in the region that the collapse in the currency had everything to do with an attack on the currencies of the region by well-financed international speculators. As Dr. Mahathir observed in a Wall Street Journal opinion piece that was published on September 23, 1997: “We are now witnessing how damaging the trading of money can be to the economies of some countries and their currencies. It can be abused as no other trade can. Whole regions can be bankrupted by just a few people whose only objective is to enrich themselves and their rich clients…. We welcome foreign investments. We even welcome speculators. But we don’t have to welcome share- and financial-market manipulators. We need these manipulators as much as travelers in the good old days needed highwaymen”. What was most remarkable about this statement was that its premises and its conclusion were immediately accepted by the international community, despite the fact that Dr. Mahathir did not provide any evidence to support his analysis of the role of hedge funds in the Asian financial crisis.

The first premise of Dr. Mahathir’s argument is that hedge funds act in concert to destabilize global economies. This is at best a misapprehension of the definition of a “hedge fund”. There is no such thing as a well defined hedge fund strategy or approach to investing. Rather, a hedge fund is a limited investment partnership otherwise exempt from registering with the Securities and Exchange Commission under Sections 3C1 and 3C7 of the Investment Company Act of 1940. As I note in my testimony last year before the House Financial Services Committee the available data show a remarkable diversity of styles of management under the “hedge fund” banner. The long-short strategy often associated with hedge funds captures about 30 to 40 percent of the business. The style mix has been fairly stable (in terms of percentage of funds) although there has been a dramatic rise in assets managed by funds of funds. These diversified portfolios of hedge funds are attractive to an institutional clientele. Event-driven funds focussing on private equity have risen in market share from 19% to 25% over the past decade, while the global macro style popularized by Soros has actually fallen from 19% to 3%. In my paper Hedge Funds with Style, with William Goetzmann, Journal of Portfolio Management 29, Winter 2003 101-112 we show that accounting for style differences alone explains about 20 percent of the cross sectional dispersion of hedge fund returns. The facts do not support a presumption that hedge funds adopt similar investment strategies coordinated with the objective of causing global instability. If their objective was to profit from the current instability, they were remarkably unsuccessful. According to Hedge Fund Research, the average fund this year is down 10.11 percent through September with equity hedge funds down 15.45 percent.

The second premise of Dr. Mahathir’s argument is that hedge funds are risktakers – gunslingers on a global scale. While it is true that the aggressive incentive fee structures (often 20 percent of any profits on top of a management fee of about 2 percent of assets under management) appear to encourage risk taking, career concerns are an offsetting factor. Given that the typical hedge fund has a half life of five years or less and the fact that it is hard to restart a hedge fund career after a failure, managers can be quite risk averse as we document inCareers and Survival: Competition and Risk in the Hedge Fund and CTA Industry, with William Goetzmann and James Park, Journal of Finance 61 2001 1869-1886. According to a recent Wall Street Journal article (10/14/2008)some of the few remaining successful hedge fund managers such as Steven Cohen of SAC CapitalAdvisors, Israel Englander of Millenium Partners and John Paulson of Paulson & Co (who is scheduled to appear in the November 13 hearings) have taken their funds out of the market and are in cash investments.

This last result seems at variance with popular wisdom that has arisen around some recent and spectacular hedge fund failures. The failure of Amaranth, a multi-strategy fund with more than $8 Billion assets under management, with more than 80 percent invested in a natural gas trading strategy, is often cited as an example of undiversified financial risk exposure. However, a close reading of the U.S. Senate Permanent Subcommittee on Investigation’s report on the Amaranth blow-up, Excessive Speculation in the Natural Gas Market shows clearly that excessive risk taking took place in a context of poor operational controls, where trading limits were exceeded multiple times and ordinary risk management procedures were dysfunctional. In recent research forthcoming in the Financial Analysts Journal Estimating Operational Risk for Hedge Funds: The ω-Score, with William Goetzmann, Bing Liang and Christopher Schwarz we argue that operational risk is a more significant explanation of fund failure than is financial risk, and that financial risk events typically occur within the context of poor operational controls.

Given that the initial premises are false, it is not surprising to find that the strong conclusions Dr. Mahathir draws from them are also false. In Hedge Funds and the Asian Currency Crisis of 1997, with William Goetzmann and James Park, Journal of Portfolio Management 26 Summer 2000 95-101 we show that while it is possible that hedge funds involved in currency trade could have put into effect the destabilizing carry trade Dr. Mahathir describes, there is no evidence that these funds maintained significant positions in the Asia currency basket over the time of the crisis. As to the question of illicit enrichment that Dr. Mahathir charges George Soros with, his funds did not increase in value, but actually lost five to ten percent return per month over the period of the crisis.

From a point of pure logic, there cannot be any factual basis for any of these claims. Malaysia is fortunate in having a very fine and able Securities Commission. If there were any factual evidence at all to support a claim that Soros had intervened in the markets to bring down the Ringgit, it would have been produced by now. I should note that the silence is deafening. I suspect that what is really going on is that Soros was an expedient target of opportunity. The only remaining question is why, given the lack of evidence, Dr. Mahathir felt compelled to bring such serious charges against the hedge fund industry in general, and George Soros in particular. There is an interesting story here which I document in Hedge funds: Omniscient or just plain wrong, Pacific-Basin Finance Journal 9 2001 301-311.

It is interesting to note that Dr. Mahathir’s feelings about currency speculation have changed over the years. In the shark-infested waters of international Finance the name of Malaysia’s central bank, Bank Negara stands out. In late 1989, Bank Negara was using its inside information as a member of the club of central bankers to speculate in currencies, sometimes to an amount in excess of US$1 billion a day. The US Federal Reserve Board had advised Bank Negara to curtail its foreign exchange bets, which were out of proportion to its reserves which at that time were about US$7 billion. At the time, Dr. Mahathir defended this currency speculation, referring to it as active reserve management and was quoted by the official Bernama News Agency in December 1989 as saying “We are a very small player, and for a huge country like the United States, which has a deficit of US$250 million, to comment on a country like Malaysia buying and selling currency is quite difficult to understand”. According to a report in the Times of London (4/3/1994) . Bank Negara came something of a cropper in 1992 when it thought to bet against George Soros on whether Britain would stay in the European Rate Mechanism (ERM), and promptly lost US$3.6 billion in the process and would end up making a US$9 billion loss for 1992. Malaysia’s loss was Soros’ gain.

http://www.financems.com/the-role-of-hedge-funds-in-financial-crises-stephen-brown.html

Danger of hedging your bets

John Collett
March 17, 201


The promise of high returns and low risk proved too good to be true.

Hedge funds were sold to small investors as a way to get a slice of the action that had been available only to wealthy individual investors or institutional investors.

But many hedge funds have proved a disappointment. The money in some, such as Astarra, went missing. Others, notably Bernard Madoff's hedge fund in the US, were no more than Ponzi schemes where new money was used to pay existing investors high returns.

Most hedge funds have produced poor returns and many have closed, or are in the process of closing, and are returning money to investors. Some other managers have frozen or restricted redemptions from their funds.

Before their reputations were shredded by the financial crisis, hedge fund managers operating in tax havens in the Caribbean or in the US and Europe were regarded as among the best and brightest of the funds management industry. They rewarded themselves handsomely. The funds tend to have hefty performance fees and, in the good times, hedge fund managers made a fortune for themselves.

They promised the low risk of fixed interest with the high returns of shares. These two things - high returns and low risk - have long been regarded as incompatible in the same investment. They also promised returns that were not correlated to the performance of the sharemarket.

In 2001, just after the launch of several hedge funds aimed at small investors, a leading financial planner, Robert Keavney, said there was "nothing on this planet that is more or less guaranteed to give double-digit returns every year". He said investors had other options available to them in volatile periods, such as fixed interest, property and cash, which are not correlated to the sharemarket.

The hedge fund promoters promised returns of between 10 per cent and 15 per cent a year after management fees, over at least three years, regardless of the direction of share and bond markets. For small investors, hedge funds were bundled up into one offering by the big fund managers. Investing in several hedge funds through "fund of hedge funds" was considered more prudent for small investors because individual hedge fund managers were considered too risky. Hedge funds are mostly small businesses and usually not subject to regulation, though there are moves by governments overseas to bring them into the regulatory net.

The funds of hedge funds invested in up to 30 underlying hedge funds across a variety of impressive-sounding hedge fund strategies. Some of the more popular strategies include "long short", which is where the manager bets the price of some stocks will fall and others will rise, and "macro" strategies, where the manager looks for small pricing differences between markets.

From their launch in the early 2000s until the crisis in 2008, most were producing average annualised returns of 8 per cent or 9 per cent - just below the promised 10 per cent to 15 per cent.

It took the crisis to disprove one of the key claims of the funds of hedge funds: that their returns were mostly not correlated to sharemarkets. When sharemarkets around the world dropped by about 25 per cent in Australian dollar terms during 2008, the returns of most of the funds of hedge funds dropped by about as much.


One factor hampering their performance was the hefty investment management fees. Most hedge funds charge their small investors an annual fee of 1 per cent to 2 per cent of the money invested and a performance fee of 20 per cent of any returns above zero or the cash rate. By comparison, most share funds charge fees of less than 0.5 per cent a year.

The head of research at Morningstar, Tim Murphy, says part of the reason for the poor performances of hedge funds during the crisis was because many were highly leveraged. He says many of the trading strategies produced fairly small returns and they borrowed to magnify these returns. But when credit markets dried up in 2008, many funds had trouble borrowing.

Another problem with hedge funds was illiquidity. Investors wanted their money back and so did lenders to the hedge funds, forcing them to sell their assets at the worst possible time at poor prices with their returns being savaged as a result.

The average annual returns over the past five years of the funds of hedge funds, given in the table, range from minus 12 per cent to 2.27 per cent. Murphy says it is "hard to argue" that small investors have been served well by their investments in hedge funds.

UNDERACHIEVEMENT
* Hedge fund promoters have failed to deliver on their promises.


* Hefty fees leave even less for small investors.


* As a result of the financial crisis, many had to freeze redemptions.


* Others are slowly handing back money.

http://www.businessday.com.au/news/business/money/investment/danger-of-hedging-your-bets/2010/03/16/1268501456367.html?page=fullpage#contentSwap1

Hedge funds suffer worst year on record

Hedge funds suffer worst year on record
Hedge funds had their worst year on record in 2008 with up to 300 funds worldwide closing down.

By Helia EbrahimiLast Updated: 8:55AM GMT 15 Jan 2009
Research by Hedgefund Intelligence also revealed an average 12pc fall in the value of hedge funds' investments.
By a median figure, hedge funds in Europe outperformed their American and Asian peers for the first time, down only 4.6pc in the 12 months, according to research based on data from 1,500 funds.
Although 2008 was the industry's worst annual performance, the results show the sector did not perform as poorly as has been suggested by some commentators. It also outperformed the FTSE 100, which fell 31pc, and the Dow, which plunged 34pc.
Some strategies were particularly hard hit, with emerging market equity funds crashing 31pc over the year, equity hedge funds down 13pc; and emerging market debt off 10pc.
In contrast, managed futures funds were the clear winners of 2008, up 16.17pc.
Some analysts believe institutional investors forced into redemptions will this year start to re-invest in hedge funds that are performing well. However, with many still forecasting industry assets could be wiped out by, there are likely to be many more casualties in the next 18 months.

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/4241934/Hedge-funds-suffer-worst-year-on-record.html

Those that went with Madoff chose faith over evidence

Who isn't a Madoff victim? The list is telling.
Although many smart people seem to have been taken in, one expert argues that anyone who really did their homework would have seen the warning signs.
By Nicholas Varchaver
Last Updated: December 17, 2008: 10:14 AM ET

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NEW YORK (Fortune) -- As the number of victims of Bernard Madoff, the criminally charged founder of the investment firm that bears his name, seems to multiply with the speed and force of a hurricane, certain types of investors seem to be absent -- so far, anyway -- from the casualty list.
That's no accident, argues James Hedges IV of LJH Global Investments, a boutique firm that invests in hedge funds and private equity for high-net-worth families. In other words, score one for the big institutions that stick to standard rules rather than allowing their managers to invest on personal connections or hunches.
"There's no Duke Endowment [among the list of Madoff investors]," Hedges says. "There's no Harvard management, there's no Yale, there's no Penn, there's no Weyerhauser, no State of Texas or Virginia Retirement system."
The reason is simple, in Hedges' view. Letting Madoff manage your money "wouldn't pass an institutional-quality due diligence process," he says. "Because when you get to page two of your 30-page due diligence questionnaire, you've already tripped eight alarms and said 'I'm out of here.' "
In short, in Hedges' opinion, any sophisticated entity that actually did its homework would have seen the warning signs.
Hedges got the chance to see those signs up close: In 1997, when he was advising the Bessemer Trust, the giant wealth manager, he visited Bernard Madoff to discuss investing with Madoff's firm.
"I found him stylistically like a lot of traders: fast-talking, distractable, not remarkable," Hedges says of Madoff. But during their two-hour meeting, Hedges says, "there was one red flag after another."
For starters, he couldn't grasp Madoff's investing strategy. "I kept saying, 'you've got to explain it to me like I'm in first grade,' " he says. To no avail.
Then there was the fact that Madoff was charging no fees other than trading commissions: "The notion that something is fee-less -- which is what they largely proferred -- is too good to be true."
The fact that Madoff's operation was audited by a microscopic accounting firm also worried him. "He was also so secretive about his asset base -- that was another red flag."
In the end, Hedges was uncomfortable and Bessemer decided not to let Madoff manage any of its money.
In Hedges' view, those that went with Madoff chose faith over evidence. "You've got people who

• were disintermediated [i.e., didn't have a professional representative], or
• unsophisticated, or
• went in through a personal relationship.

That's what a con man is -- a confidence man is somebody that engenders a relationship and then subsequently lures somebody into doing something that they shouldn't do." (According to the federal criminal complaint against him, Madoff has confessed that he ran a "giant Ponzi scheme." His lawyer, Ira Sorkin, declined to comment.)
Certainly many of the institutions that turned to Madoff will challenge Hedges' views, as many will face litigation from their own clients. So far, two of the large fund-of-funds with the largest sums under Madoff's control, Tremont and Fairfield Greenwich, have already asserted that they conducted extensive due diligence before investing. Many others will take the same position.
Should Hedges' opinion be borne out and corporate and state pension funds remain absent from the roster of Madoff victims -- of course, there will be many more names added to the list -- it will only heighten the Madoff tragedy. Because, in the end, it would show that this was one investing disaster that could easily have been avoided.
First Published: December 16, 2008: 5:51 PM ET