Should We Fear Hedge Funds?

Abstract

The collapse of a sizeable hedge fund recently has reignited the concerns of some market participants and regulators over the absence of formal oversight for the industry. It reminded them of the perceived systemic risk posed to the financial market by LTCM some five years ago. Since then, the hedge fund industry has rebounded significantly with total investment in it exceeding an estimated £500 billion and still growing fast. The recent calls for the formal regulation of hedge funds have not taken cognisance of the fact that it is already monitored albeit indirectly through various federal securities laws in the US and the oversight of hedge fund managers and capital suppliers to the industry in the UK. The light touch regulation by existing financial regulators probably enabled it to function as a viable business providing good profit enhancement opportunities for investment banks and liquidity to other market participants. Empirical evidence to date has also supported findings about its financial viability despite some concerns expressed over its dark side in part brought about by the general opacity of the business. On balance, hedge funds have therefore provided more good than harm to the global financial markets and as such should not be feared. Instead, they should be nourished through best practice codes. In the case of the UK, it should continue to enjoy light touch regulation. This will help motivate the industry to expand in the UK.