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Killik&#39s short shrift for shorting effect

Stockbroker Killik & Co last week laid out its explanation for this winter&#39s chill across the world&#39s stockmarkets.

While it acknowledged that factors such as a buyers&#39 strike in technology are partly responsible, it also turned its fire on hedge funds, suggesting their recent proliferation in the UK has been a major contributor to slowing markets.

The last year has seen more UK hedge fund launches than ever before, with many investment houses losing high-profile active fund managers to the hedge fund industry.

Killik and Co says fund managers&#39 methods of shorting, where hedge fund managers sell borrowed stock and then buy it back at a lower price, is driving falling markets even lower.

In the April edition of its monthly newsletter, Killik says: “Shorting is a relatively recent phenomenon in the UK. It is becoming widespread and will change how markets operate in the future. Probably for the first time, publicly available services mean that everyone can short. Until the Stock Exchange produces more detailed statistics, we can only guess at the real extent but the consequences are all too clear – swinging momentum and volatility.

“There is a buyers&#39 strike as far as the technology sector is concerned but that is not true for other sectors, yet the effects of shorting is proving detrimental across the board. All the momentum is on the downside and that is likely to continue until there is a change in investor confidence.”

Killik is calling for a debate on shorting. With no UK vehicle to run hedge funds onshore, all funds are based offshore and remain largely unregulated. Killik says that although it understands the difficulty of regulating hedge funds, greater transparency in the market would be an advantage.

In the US, where hedge funds have had a serious presence for many years, there are already shorting regulations.

Senior partner Paul Killik says: “We would like to have an idea of how large the short positions are in some UK securities. It would be sensible at least to have some rules in place.” He says London is set to see increasingly volatile markets but controls on shorting could reduce this. As shorting increases, he believes it is becoming difficult to tell whether or not a price is going down because genuine investors are selling or hedge fund managers are taking heavy short positions.

The FSA says it is considering more regulation of the hedge fund industry although chairman Sir Howard Davies has also made it clear that he does not particularly want to bring the funds onshore.

With the FSA&#39s current regulatory overhaul, one exc-use has been that the regulator simply does not presently have the time to regulate hedge funds.

But the proliferation of these funds is putting increasing pressure on the FSA to act.

In the last quarter, the first mainstream retail hedge fund products have emerged, with offerings from Henderson, Morley, Matrix and Deutsche.

Although these are all funds of hedge funds which carry much lower levels of risk, they still provide retail investors with direct access to the hedge fund market. The fact that retail investors, as opposed to institutional investors, are increasingly involved with hedge funds has made the FSA take notice.

Matrix Securities director Bridget Cleverly says: “I agree with Killik that the FSA should be encouraged to regulate hedge funds and bring them onshore.

“I recently asked someone at the FSA why it was possible to buy hedge funds in an investment trust and not in an openended structure. The answer was simply that we have two Acts of Parliament – the Companies Act, which deals with investment trust regulations, and the Financial Services Act, which deals with open-ended collective investments.”

Cleverly believes the current regulations are nonsensical. While holding hedge funds within a fund reduces risk, she says an investment trust adds a degree of volatility, with the issues of discounts and premiums to take into account. She would like to see open-ended funds allowed to hold hedge funds as well as closed-end funds.

She says: “Part of the problem is that while some investment products have very effective associations for lobbying Parliament, the hedge fund&#39s trade body has no lobbying presence.”

Investors remain cautious. Simpsons partner Andrew Merricks says: “I don&#39t think the retail market is quite ready for them yet. I think people need to invest in the stockmarket and accept the downturns with the upturns. The fund management industry is getting very excited about hedge funds but I do not think investors are yet.”

The first retail hedge fund products have had minimal success although this can perhaps be attributed to all-round low investor confidence at the moment. However, most fund managers have some form of strategy for breaking into the retail hedge fund market over the next few years.

Once the market starts to reach significant levels or the industry is hit with a hedging disaster, perhaps the FSA will take on board the calls of companies such as Matrix and Killik.

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