Hedge fund industry continues to struggle with scandal and regulation

Continued market volatility coupled with uncertainty over the ending of quantitative easing, the fall-out from the resignation of the International Monetary Fund head and worries over China continue.

One cannot have everything the way he would like it. A man has no business to be depressed by a disappointment, anyway; he ought to make up his mind to get even.
A Connecticut Yankee in King Arthur's Court by Mark Twain (Samuel Langhorne Clemens) (1835-1910), American author and humorist.

All is not well in the hedge fund world. An embarrassing row with former employees, allegations of spying and in appropriate undercover shenanigans are plaguing Ikos, one of Europe’s more successful managed futures funds. On the other side of the Atlantic, the US industry is facing continued intense scrutiny on abuse of insider trading rules in the aftermath of a jury conviction for Raj Rajaratnam.

It is certainly clear from these two factors alone the political pressure on hedge funds to become more transparent about how they are run and make their profits is not abating. While one could argue there is an element of political grandstanding, particularly by Republican Senator Charles Grassley who continues to push Securities and Exchange Commission (SEC) chairman Mary Schapiro to explain just how the regulator has handled allegations of suspicious trading, the industry is far from going back to business as normal.

In Europe the ham-handed handling of the departures of research staff at Ikos and allegations of theft of proprietary information has put the industry back in the spotlight. Regardless of how inappropriate or correct the allegations are, it is once more making the public and politicians aware of the industry – and not in a good way.

Disappointments are to the soul what a thunder-storm is to the air.
Johann Christoph Friedrich von Schiller (1759-1805), German poet, dramatist and historian

While institutional investors are still keen to put money into hedge funds, they are becoming more vocal in their criticism of the industry and much more explicit in calling for the kinds of behaviour they want to see.

The latest initiative from the Alternative Investment Management Association (Aima) issuing a guide for investors and managers written by its investor steering committee, reflects preferences and priorities for institutional investors and investment allocations.

These focus on best practice in areas of greatest concern for institutional investors such as operational and organisational infrastructure. The main authors of the guidelines include some big name investors including the California Public Employees Retirement Scheme (Calpers) and a couple of multi-billion-dollar European investors, private bank Union Bancaire Privée (UBP) and pension funds USS and British Airways Pension ­Investment Management.

These are not voices that can or should be ignored. Aima’s initiative highlights where the industry should be concentrating: performance reporting, terms and conditions, control of assets and transparency.

The guide comes out as the industry is about to implement some of the biggest changes in the way it operates imposed on it by the US Dodd-Frank Act. The extraterritoriality of the legislation will impact hedge funds outside the US as much, if not more, than inside.

Investors overall are becoming more vocal about how they want the industry to behave if it is to continue to attract large investments. Public opinion matters to investors just as much as the imposition of regulation. Even if managers remain sceptical about the depth of public reaction against hedge funds they cannot and should not ignore calls from the largest investor group for changes in the way it ­conducts ­business.

The quest for certainty blocks the search for meaning. Uncertainty is the very condition to impel man to unfold his powers.
Erich Fromm (1900-1980), German-born American social philosopher and psychoanalyst

Managers may rail against what they see as disproportionate regulation imposed by governments and a hostile media but it has little choice but to start behaving in a more responsible and responsive way.

At the same time the world continues to present continued volatility with far more uncertainly impacting markets. More managers are now admitting they believe volatility and violent swings will be the order of the day for the next 10 to 15 years. Interest rates cannot remain at near zero forever and the withdrawal of liquidity from the system, particularly as the US disengages from quantitative easing, will change market dynamics even more. Whether QE2 will be followed by another version, somewhat like a Hollywood remake of a successful first-time film, is almost a side issue.

There are plenty of other developments to keep markets in turmoil. The allegations against and subsequent resignation of the International Monetary Fund’s head, Dominique Strauss-Kahn, has ramifications way beyond the international organisation. Its impact on the French presidential elections is already causing concern but more interestingly has been the reaction by emerging markets to the convention that a European heads the IMF.

The ability of some of the big players, including the Bric nations of Brazil, Russia, India and most particularly China, to put pressure on the organisation is significant. Even more than the Group of 20, the ability of nations developing their economic reach is being felt throughout the whole world. Their collective voice is impaired more by an inability to co-ordinate than by economic clout.

If (or rather when) the Bric governments together with other developing economies find a way to work together, the world order really will undergo a significant shift southwards and eastwards.

Meanwhile, as much concern is being lavished on China’s leadership as it tries for a soft landing as on worries about the ending of QE2. Inflation is a real concern in both the US and China. In Europe the will they/won’t they game of Russian roulette continues as the eurozone seems stuck in a repeating loop of inaction and poor judgement concerning sovereign debt (bordering on default) in the weaker European member states.

These three factors combined with continued unrest in the Middle East, flip-flopping commodity prices and the prospect of significant elections over the next 24 months (particularly the US presidential race which is likely to distract President Barack Obama at a time when he should be focusing much more on the economy) means the world is likely to remain stumbling around in the woods for some time yet.

Not to be absolutely certain is, I think, one of the essential things in rationality.
Am I An Atheist Or An Agnostic? by Bertrand Russell (1872-1970), British author, mathematician and philosopher