What the new breed of hedge funds have to offer

The hedge fund industry has matured at a faster pace than anyone could have anticipated. Sure, there are still problems, but the old habit of tarring all hedge funds with the old brush of suspicion must surely be left in the past.

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Barely a week goes by without a scare story foretelling chaos in financial markets because of an imminent unravelling of the hedge fund industry.

You can almost hear the deep resonance of a news anchorman intoning the impending crises as you scour the headlines: demise of leading US broker means hedge funds won’t be able to manage their risks; probe into leading UK firm raises fears that hedge fund trading is rife with the illegal use of inside knowledge from bank pre-deal marketing; credit event of major US firm to presage unravelling of synthetic CDO market, bringing swathes of the hedge fund industry to its knees.

Will these foretellers of doom never learn? Look at the actual evidence. While a few hedge funds who used Refco as their prime broker may have had some short term inconvenience managing their risk positions, there was no shortage of other counterparties ready, willing and able to provide them with access to the market.

Unsubstantiated allegations of malpractice in the marketing of deals is hardly new (Eliot Spitzer made a career out of it, and what did he actually achieve?) and there will always be people or firms prepared to push market practices to or past their limit. But does that need another regulator warning of the potential need for an industrywide investigation, as the UK’s FSA seems to be doing?

Then take the long-anticipated filing for bankruptcy of auto parts manufacturer Delphi. A large number of synthetic CDOs with exposure to Delphi are likely to suffer negative ratings actions. This will hit some hedge funds and prop desks invested in them. But the structured credit market passed its test in May when General Motors and Ford were downgraded. The great correlation unwind was expected to create any number of victims, but the fears were never realised.

The important thing to remember is that the hedge fund industry has matured at a faster pace than anyone could have anticipated. Sure, there are still problems – for example, the way that some traders have let hedge funds get away with assigning credit derivatives positions originally written with one dealer and then passing them on to another without first obtaining the written consent of the original counterparty, creating a huge backlog in unconfirmed and uncleared transactions.

But the old habit of tarring all hedge funds with the old brush of suspicion must surely be left in the past.

It’s something that CEOs are going to have to come to terms with, and fast. Ask most corporate executives about hedge funds and they’ll be stricken with anxiety about the investor who owns just 5% of his stock but thinks he can use it to actively change the way the company is run.

Our cover story tells a different tale, of CEOs who have been only too happy to accept hedge funds as strategic investors in their business. As they seek new ways to generate returns, hedge funds are taking a leaf out of private equity (whose potential buying power they dwarf) and becoming corporate financiers.

Investment banks are repositioning some of their best coverage officers to cover hedge funds in this way. One bank recently, and discreetly, completed the strategic disposal of a $500 million firm in just 45 days from being approached by its selling client. The buyer was a single hedge fund.

Now that’s worth the market’s attention.

And corporate executives who are too reactionary to accept what hedge funds have to offer could soon come to regret looking a potential gift horse in the mouth.

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What the new breed of hedge funds have to offer

The hedge fund industry has matured at a faster pace than anyone could have anticipated. Sure, there are still problems, but the old habit of tarring all hedge funds with the old brush of suspicion must surely be left in the past.

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