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Fri, May 13, 2005 - Page 12 News List

Markets nervous over rumors of hedge fund frailty

SPECULATION Though there are no confirmed instances of problems, some say trouble could lie ahead, amid some abrupt market shifts recently


Jitters are growing in financial markets about the potential for failure of hedge funds, largely secretive and unregulated pools of capital, seven years after a spectacular collapse of one such fund.

A number of reports and market rumors circulated in recent days about potential problems with hedge funds, although there have been no confirmed instances of difficulties at any of the funds.

But because hedge funds operate largely in secret, with little or no government oversight, some analysts have been concerned about the possibility of a failure and a subsequent ripple effect on banks and financial markets.

"In the last five years you've had more and more hedge funds managing more and more assets with more and more borrowed money," said AG Edwards analyst Scott Wren.

"When you've borrowed a lot and the market goes against you, you increase your chances of major losses."

"One of the first things you learn about financial markets is that if there's smoke, there's fire," said Robert Brusca, chief economist at FAO Economics, who added that he had no knowledge of any specific hedge fund problems.

Hedge funds, generally operating with money from wealthy investors, can try to beat the overall market by placing risky bets, "short sales" that seek to capitalize on falling prices, and by borrowing money, which can magnify both gains and losses. They may invest in stocks, bonds, commodities or "derivatives" that seek to mimic the performance of another security.

Reports said some hedge fund managers may have been taken by surprise by the abrupt movements in some markets, including the downgrading of credit ratings of Ford and General Motors bonds to "junk" status, and an offer for a big stake in GM's equity by billionaire Kirk Kerkorian.

David DeRosa, president of DeRosa Research, which advises hedge funds and other investment managers, said he was unaware of any specific hedge fund difficulties.

"There are a lot of rumors around. I have no way of knowing if they're true," he said.

Stoking fears is the weak performance of hedge funds this year. Overall, hedge funds lost 1.8 percent in the first four months of the year, according to Hennessee's Hedge Fund Index, which tracks the performance of about 900 managers.

But hedge funds that trade convertible bonds lost 3.5 percent last month on average, leaving them down 6.3 percent so far this year, according to Hennessee.

DeRosa said: "It doesn't matter if the hedge funds' performance is good or bad, but if a hedge fund is forced into liquidation, it would imply a lot of buying and selling of securities," and the potential for destabilization.

The ripple effect of a hedge fund collapse could affect banks that lend money to the funds, and other securities if a hedge fund is forced to sell in a liquidity crisis.

The fear on financial markets is a repeat of the situation with US hedge fund Long Term Capital Management (LTCM) in 1998, which destabilized global financial markets already in turmoil over financial crises in Asia and Russia.

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