Credit Dips Put Hedge Funds' Feet To Fire

The recent market turbulence will put to the test theories of whether hedge funds actually cause bigger swings, or whether the unregulated entities can truly offer safe harbors within a storm, according to Bloomberg columnist Chet Currier.   “If credit turmoil spreads from the carnage in the subprime mortgage business, hedge funds stand to become the featured players in a heroes-or-villains drama,” he worte. “Should the shake-up that began in late February turn into a messy, drawn-out affair, hedge funds are handy candidates for blame.”   Hedge funds have a reputation as so-called carry trades, through which they borrow money someplace cheap—for example the Japanese money market—and invest it for a higher return elsewhere.   If, on the other hand the storm passes quickly, hedge funds could be the heroes, since they can act quickly and play the market unfettered from all sides, Currier said.   Also, unlike the typical investors, hedge fund managers burned by market swings don’t get market shy; they get active. The 1.4 trillion industry pales in comparison to the $10.5 trillion U.S. mutual fund market, but mutual funds are far more fettered and unable to make the same types of big, quick moves as hedge funds.   In fact, data from the Investment Company Institute shows that the average mutual fund has only 4% of its assets in liquid cash.   Likewise, private-equity funds draw mainly from borrowed money, and that money disappears during credit crises.   Also, hedge fund managers are rarely subject to the security loyalty that plagues many other investors, especially those with securities they may have had for decades. “Hedge-fund managers have often been portrayed not merely as dispassionate, but as pitiless self-seekers wielding frightening amounts of power,” wrote Currier. “A measure of cold calculation may be just what is wanted when most investors get caught up in the emotions of a turbulent market. While the herd is stampeding in one direction, nobody is better equipped than hedge funds to get a little movement going the other way.”     The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.