Hedge Fund Influence

Does hedge fund influence extend too far?

There is an image of hedge fund managers being men who stand up and be counted and put corporate boards under pressure. This image has been spawned largely by the work of one man, Carl Icahn from the US. Whilst his protests and open letters cause headaches for boards, most hedge fund managers are short term traders and only minimally interested in the goings on at board level. Causing too much trouble could compromise their ability to operate.

To be sure, there are many other hedge fund managers who causetrouble for company management. The power they wield can be quite astonishing at times, though in truth this relates to the fund management industry as a whole rather than just hedge funds.

This power comes from the large quantities of corporate stock they own on behalf of their investors. Some of these managersdeliberately interfere with management plans and corporate decision making in the hope of 'unlocking shareholder value'. Whether they actually manage this is difficult for me to say for certain.

Read Stuart's stock market blog here.

On the one hand, causing a fuss in the stuffy world of corporateboardrooms seems quite appealing to an investor. A Chairman iscertainly more likely to listen to a fund manager than anindividual investor. However, it is easy to argue that thisinterference is just meddling. After all, who would you presume can manage a company better, a board of directors and managers or a young hedge fund manager?

A recurring theme in the story of hedge funds is of 'math whizzes'. The hedge fund industry is involved in some of the most complex financial transactions known to man. Many of these transactions involve borrowing money.

For an investor, this leverage adds to the risks substantially. The occassional news stories that creep out about pension fundsplanning to invest in hedge funds should worry us all.

Many of their investments are made with highly complex derivative contracts. Most are known as OTC, or over the counter, and are traded between parties rather than on an exchange. This makes monitoring, understanding and assessing the risk of these contracts virtually impossible from the outside.

Warren Buffett no less, has commented in the past about the risks these contracts place on the financial system. Their sheercomplexity means that anyone capable of understanding them can earn 10 or more times the salary in the private sector than working for a regulator. Good help becomes hard to find.

Click here to read my stock market guide for beginners

The big worry to the financial world is that of unmatched creditderivative trades. I don't pretend to understand these fully and so I shant try to fudge expertise here. However, it is believed that roughly 20 percent of all credit derivative trades are unmatched and that this accounts for over US$5 trillion.

Hopefully, Wall Street will fix this monster timebomb before itexplodes. Great progress has certainly been made to lower the risks to the financial system. Lack of transparency and tradecomplexities will slow these efforts. With so many hedge fundslocated offshore, they are likely to continue to play a part inthis risk.

They operate deliberately outside the traditional system and their very existence will be compromised by rules and regulations. This makes regulating hedge funds little more than a dream. As is typical in the offshore world, they have all the money and none of the rules whilst the regulators have all the rules and none of the money.

* This article was first published in my newsletter in November 2006 *

Hedge Fund

Hedge Fund Investors

Hedge Funds: ill fated and greedy risks

Most Popular Pages: Retirement Planning | Stock Market For Beginners