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A competitive hedge in delivering returns

The worldwide growth of hedge funds over the past 10 years has been amazing. There are now more than 8,000 hedge funds with over $1tn of assets under man- agement. Recent publicity about the earnings of some of the top managers in the field has raised the profile of this supposedly new phenomenon even further.

With this in mind, it is a bit surprising to note that the FSA has recently issued two discussion papers on the impact of hedge funds in the UK.

In an FSA press release, managing director of wholesale markets and institutions Hector Sants says: “We view hedge funds as a significant, useful and growing asset class through their role in providing market liquidity and diversification options for investors.

“However, the activities of hedge funds do pose risks to the UK’s financial markets and the work of the FSA and it is right that we fully understand them.”

A note of surprise and concern may be sounded at the seemingly late recognition that hedge funds are too big and too influential to be ignored and that they have changed the nature of the industry.

Despite this, it is pleasing to see the FSA acknowledge that its focus has to cover a wide range of investment products which are mark- eted to retail consumers and institutional clients.

Any products which demonstrate volatility, complexity and illiquidity create risk. Ensuring that it is communicated, managed and monitored should be a key role of the regulator.

Some of the biggest risks surrounding hedge funds are:

  • The number of small boutique firms in the industry.
  • Administration and operational inadequacies.

However, it is inevitable that these two key risks will to a degree be mitigated by the process of maturation which takes place in most emerging industries. This is where we see mainstream players entering the market and a process of consolidation taking place.

Both these developments will allow scale and competence to emerge as key success factors and this can only help naturally reduce some of the risks involved.

Where a hedge fund operates within the compliance and operational framework of a bigger organisation, the ability to manage risk and provide consumer protection is somewhat enhanced.

Despite the major risks hedge funds pose to the market and investors, one of the most important and beneficial impacts of the hedge fund phenomenon has been to refocus the traditional industry on the importance of investing for absolute returns.

In recent months, we have seen a spate of absol- ute return products being launched by major investment groups.

Investors, whether they are private retail investors, pension schemes, charities or life funds, chase investment returns. Too often, the experts forget this and become obsessed with an asset class and its particular characteristics. The result is an ever changing focus on the flavour of the month, for example, property, UK equities or hedge funds.

Being in an industry which accepts responsibility for delivering real returns to investors must be one of the key routes to rebuilding consumer confidence.

Like most of us in the industry, I look forward to the FSA’s next steps towards creating a safer, more transparent environment for investors.


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