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Economics & Finance

In defence of hedge funds

Karen Cho |

Hedge funds have come in for scrutiny of late, particularly for their role in the financial crisis. According to Christopher Fawcett, CEO of Fauchier Partners, which manages hedge fund and alternative investment portfolios, hedge funds have become a scapegoat as they are an easy target.

“I think there is a general tendency when things are going wrong, to find something or somebody to blame. And in the early stages of the crisis, the banks were not being directly blamed – and the hedge funds were.”

“It was convenient from the point of view of politicians – and that lasted for a while. As more people have become more aware of the facts, it has been less the case. Banks are geared towards 25, 30, 40:1, whereas the average hedge fund is about 2:1.”

Speaking in defence of hedge funds, Fawcett told INSEAD Knowledge on the sidelines of the INSEAD Leadership Summit in Europe, that hedge funds just do not have the kind of influence to upset the natural order of things. That is, hedge funds do not move markets. 

“They’re not big enough. At the moment, hedge funds are about three per cent of global money on the management. They use a bit of leverage - about 1.5 times. That means if you take the total balance sheet of all the hedge funds in the world, it’s smaller than the balance sheet of a big bank like JPMorgan or the Royal Bank of Scotland.”

This does not mean, however, that hedge funds are in the clear. Fawcett believes that there is still room for what he calls “the right type” of regulation, particularly in the United States, and not just because it was ‘ground zero’ for our current financial crisis.

“In Europe, all hedge funds managers are regulated; in the US, currently they’re not. And there is a move that all hedge funds managers in the US should be regulated, and I think that everybody would welcome that.”

“That leaves the question of the fund they manage, which is typically in a zero tax jurisdiction like Cayman or Bermuda, and those are not technically regulated. What we are likely to see coming out of the financial stability forum are rules whereby the larger hedge funds post their positions to the regulators, so the regulators are made aware of the positions that they hedge funds.”

While regulation does serve a purpose, Fawcett says it should by no means be regarded as a failsafe.

“Let’s not forget a lot of the entities that got into trouble were regulated, they were audited … And in many cases, what’s behind all this, are the credit ratings agencies, S&P and Moody’s, and that wasn’t just a creation of the private sector, because all the bar for capital equity ratios were the central banking sort of mantra, were based on credit rating agencies, so it’s a systemic failure of regulation.”

Instead, he calls for a “complete rethink” and a more common sense approach regarding risk assessment. “It has become highly quantitative, and the belief in the credit ratings agencies was quite irrational.”

Still, Fawcett remains optimistic that we will ride out the crisis in due course. “Apparently if you look back at recessions which were triggered by a credit crunch or credit banking crisis, there’s never been a V-shaped recovery – which doesn’t mean that things won’t stabilise. My own guess is they will stabilise somewhere along the current levels.”

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