Hedge Funds Challenges in a Changing World

Never before in its short history was the hedge funds community confronted with the challenges nor the pressures it is facing today, following a six-year boom with Madoff’s scandal coming as the icing on the cake following the US financial crisis.

With investors already becoming more demanding with regards to fees, transparency and regulation, these and other industry standards are expected to become topics of contention within this once powerful industry globally and in the region.

Hedge Funds managers and providers are expected to share their plans to make the industry more transparent and investor-friendly and to show the steps they are taking as a community to self-regulate the industry after a miserable year that saw the industry face its worst 12 months on record.

In fact, hedge funds are already facing increased competition in addition to all the other challenges that the financial turmoil has brought about. Fee cuts, transparency, revealing the underlying instruments without giving away the ‘secret formula’ to copycats, due diligence, redemptions and selling pressures, less restrictions on investors and getting in new money are all topics that might change the face of the industry as we know it today, which might find itself adopting a new model.

One of the successful hedge fund managers respected by people in this financial crisis is John Paulson, whose Credit Opportunities Fund in 2007 turned a $500m investment into $3.5bn, widely believed to be the largest dollar gain ever generated by a hedge fund manager in a single year. In 2006 he realized that the growing risk of defaults on mortgages made to sub-prime US household borrowers was grossly mispriced, and he executed complex debt trades to benefit from this. John Paulson eventually made $15 billion from predicting the US sub-prime mortgage crisis. He is now one of the largest hedge funds in the world, managing approximately $35bn in merger, event and distressed strategies. Its credit funds were up by 15 per cent to the middle of December and in the past few weeks have been one of the biggest buyers of prime mortgage-backed securities. Paulson & Co’s other funds were up to 38 per cent ahead by mid-December.

Paulson is a living proof that it is not all doom and gloom for the industry. Some good news is coming out for investors, such as reduced fees in some strong performing funds, including quantitative strategy funds. Also, the UK’s Financial Services Authority dropped its ban on short-selling, or betting against, banks and insurers, and introduced a tighter disclosure regime. Also, Hedge funds will be allowed to borrow from the US Federal Reserve for the first time under a landmark $200bn program intended to support consumer credit.