Long Term Capital Management and the Hedge Fund Industry
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Introduction
The Hedge fund industry is surrounded by much controversy and debate; and that for many years. Lack of oversight, excessive returns, unclear impact on the market and more, are all subjects of concerns for market participants and the public. According to Priya Jestin on Hedge Fund Street, “on an average day, between 18 and 22 percent of all trading on the New York Stock Exchange is related to hedge funds”. The increasing role that hedge funds are playing in the market is a source of the debate surrounding them, fearing that the” too big to fail” problem arises in the hedge fund industry as well.
With low regulatory oversight, the hedge fund industry worries financial professional and small investors who do not know how to accurately assess the risks associated with hedge funds. Indeed, although hedge funds are mainly operating like mutual funds, the managers do not. Low regulation and oversight, even from the Securities and Exchange Commission (SEC) allow them to not make public information on their investment strategies or profits and losses. Another controversy is the market capacity. Alpha has become rarer and that is mainly because of the volumes traded that reduced market irregularity. Hedge funds rely much on volumes to achieve profits and their reduced performance lead the managers to increasingly rely on the remuneration model. Since 1998, systemic risk became a major part of the debate. The Long Term Capital Management (LTCM) disaster showed the huge amount of risk that hedge funds can use to achieve the required return. The latter increases systemic risk and can negatively affect the real economy too. Fortunately, LTCM was bailed out and the series of falling dominos was aborted. Although the bailed out happened, the LTCM episode shook the industry and opened the curtain on some of the problems in the hedge funds industry, demystifying the high
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Introduction
The Hedge fund industry is surrounded by much controversy and debate; and that for many years. Lack of oversight, excessive returns, unclear impact on the market and more, are all subjects of concerns for market participants and the public. According to Priya Jestin on Hedge Fund Street, “on an average day, between 18 and 22 percent of all trading on the New York Stock Exchange is related to hedge funds”. The increasing role that hedge funds are playing in the market is a source of the debate surrounding them, fearing that the” too big to fail” problem arises in the hedge fund industry as well.
With low regulatory oversight, the hedge fund industry worries financial professional and small investors who do not know how to accurately assess the risks associated with hedge funds. Indeed, although hedge funds are mainly operating like mutual funds, the managers do not. Low regulation and oversight, even from the Securities and Exchange Commission (SEC) allow them to not make public information on their investment strategies or profits and losses. Another controversy is the market capacity. Alpha has become rarer and that is mainly because of the volumes traded that reduced market irregularity. Hedge funds rely much on volumes to achieve profits and their reduced performance lead the managers to increasingly rely on the remuneration model. Since 1998, systemic risk became a major part of the debate. The Long Term Capital Management (LTCM) disaster showed the huge amount of risk that hedge funds can use to achieve the required return. The latter increases systemic risk and can negatively affect the real economy too. Fortunately, LTCM was bailed out and the series of falling dominos was aborted. Although the bailed out happened, the LTCM episode shook the industry and opened the curtain on some of the problems in the hedge funds industry, demystifying the high
References: Barboza, David and Jeff (1998) “On Regulating Derivatives” New-York Times December 15, p.C1 The President’s Working Group on Financial Markets, (April 1999), “Hedge Funds, Leverage, and the Lessons of Long-Term Capital Management” Edwards, Franklin R., (Spring 1999) “Hedge funds and the Collapse of Long Term Capital Management”, Journal of Economic Perspectives Born B., Interview with FRONTLINE, (August 2009) “Where 's The Heat On Hedge Funds” (June 2006 ) http://www.businessweek.com/magazine/content/06_25/b3989062.htm Needham, A. W. and Brause C., “Tax Management Portfolio”, Hedge Funds, No. 73