Monday, May 5, 2008

Hedge Funds: Financial Cloak and Dagger?

First made famous as a financial instrument that made spectacular hostile takeovers possible during the 1980’s “Decade of Greed”. Now used by speculators to drive up oil and food prices, will stricter regulation tame hedge funds’ unbridled avarice?

By: Vanessa Uy

Okay I’ll admit it – and so do maybe a large number of people – that the financial world’s bereft of any semblance of corporate social responsibility is what probably makes it interesting to outsiders. If ever corporate social responsibility or ethical business governance existed during the “Decade of Greed”, the movie “Wall Street” surely would have never been made. Part of the financial world’s “cash cow” that tore the financial world into two camps when it comes to the widespread adoption of corporate social responsibility are hedge funds. But before we proceed further, let us discuss first the arcane and rigmarole – infested world of hedge funds.

A hedge fund is a private investment fund that charges a performance fee and usually offered only to a limited range of qualified accredited investors. Unlike true blue Initial Public Offerings or IPO s, in which anyone with money or other requisite funds can qualify to invest. Alfred Winslow Jones was credited for inventing hedge funds back in 1949. While there is no legal definition of hedge funds under the US securities laws and regulations, the term hedge fund usually pertain to funds invested in more complex and risky investments ignored by most – if not all - public funds. As a hedge fund’s investment activities are limited only by contracts governing the particular fund, it can make greater use of complex investment strategies such as short selling, entering into the futures markets, swaps and other derivative contracts and leverage.

As the nomenclature implies, hedge funds usually avoid potential losses in the principal markets they are invested to by hedging it by any number of available methods. But a number of long-term investments had been inappropriately named as hedge funds, especially absolute-return funds. Even though these so-called “pseudo hedge funds” do not actually hedge their investments.

Hedge funds had always acquired a reputation of secrecy, a financial cloak and dagger if you will. This could cause serious headaches in its attempt to comply the transparency proviso of corporate social responsibility and / or ethical business governance. Unlike open-to-the-public “retail” funds - like US mutual funds - which are marketed freely to the public, in most countries, hedge funds are specifically prohibited from being marketed to investors who have no professional accreditation or to individuals with sufficient private funds. Sadly, this limits the information a hedge fund is legally required to release because divulging a hedge fund’s methods could unreasonably compromise their business interests. Thus limiting the pertinent information that a hedge fund is allowed legally to release.

Since a typical hedge fund’s assets can run into many billions of dollars and is always be multiplied by leverage, their sway over markets, whether they succeed or fail, is potentially substantial. There is even a continuing debate over whether hedge funds should be more thoroughly regulated. Given their current sway in the commodities markets, especially to crude oil and staple foods like rice, corn and soybeans, a more thorough regulation is indeed a long time coming. The bad news is that a more thorough regulation could be viewed by the majority in the financial world as a move from an already over regulated Keynesian style economics into a Soviet-era “Socialist Command Economy”. A move that would prove to be an anathema to an overwhelming majority in the financial world who had clung on to their Protestant / Calvinist Work Ethic like their lives depended on it.


Investing Tool said...

in my view hedge funds need to be regulated to avoid chaos in financial world.

Ferdinand said...

When talking about hedge funds, it should be everyone's responsibility to include private equity funds - commonly perceived as the hedge funds' "evil twin" that makes hostile takeovers a devastating possibility. Though most mainstream economists classify private equity funds and it's helper / side-kick hedge funds as private investment vehicles used to pool investment capital. Usually for a small group of large institutional or wealthy investors. But in practice - private equity funds are more akin to a set of assets consisting of equity securities that are used in a typical company's operation that is not publicly traded on the stock exchange. But if one embraces corporate social responsibility in his or her day-to-day business dealings, one should also remember private equity's reputation of its "Barbarian at the Gates" - style hostile takeover reminiscent of the RJR Nabisco incident of 1989.