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Opinion

Inside investment: Whither the withering hedge funds?

The financial crisis might be the making of hedge funds. Institutional investors will change the industry for the better by demanding onshore structures, independent administration and greater transparency. Mainstream financial centres should see this as an opportunity and ditch the fatuous parts of proposed regulation.

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When the erstwhile vice-chancellor of Germany, Franz Muntefering, described hedge funds as locusts it was not intended as a compliment. However, locusts, in common with other species with J-shaped growth curves, are nothing if not survivors. The population of organisms characterized by this evolutionary profile can expand at an exponential rate in a new environment. Such species are density-independent until some external force, such as changing weather, precipitates a correction in population.

After a long period of rapid growth it seemed as if hedge funds had reached this "bust" stage this time last year. A record 1,471 hedge funds, 16% of the industry, went out of business in 2008, according to Hedge Fund Research. Closures, redemptions and adverse markets combined to wipe $900 billion from the value of hedge fund assets between their peak at the end of 2007 and June this year. Other resentful investors found themselves trapped in side pockets or stuck behind gates.

Self-inflicted pain
The biggest headache of all was of the industry’s own making. The average hedge fund declined by 19% last year. Although this compares relatively well with the 38% fall of the S&P500 index it would seemingly offer scant comfort to investors who believed they were buying an uncorrelated source of alpha.

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