Regulation of Hedge Funds

As the economic crisis continues and deepens, the cries for the regulation of hedge funds grows ever louder: ‘more control to stop the greedy!”.

Let’s put aside emotion and look at facts:

  • The suspension of redemptions is unforgivable UNLESS the hedgefund manager advised the investor at the time of his investment. In my book, the suspension smacks of a unilateral change of terms. Yes, I know, most hedge funds have a suspension of redemption clause in the prospectus or contract; but the problem is, it is buried somewhere in the documentation. Yes the suspension is legal; but is it fair? In this case, legal and fair are two different things. How many investors would wade through 30 pages of small print? Suspension of redemptions ought to be fully disclosed at the time of investment.
  • It was not the unregulated hedge funds that brought about the crisis. This crisis was brought about by the regulated institutions: banks, merchant banks, brokers etc. More of the same will not solve the Maddoff type problem. What did Einstein say: ‘Insanity is doing the same thing over and over again and expecting different results?’.
  • Moreover more regulation does not mean safer. The SEC will be the institution charged with enforcing the legislation – this is the same entity that allowed Bernie Maddoff to run, for over 20 years, the greatest ponzi scheme in history. In addition, the debacle over the Stanford Group shows that the Maddoff affair was not just a momentary lapse. Why should more of the same, enforced by the same agency produce different results?
  • There is a cry for more transparency as if more transparency about the fund’s trading/investment strategy would make the investment safer. The fact is for some funds, the strategy is there for all to see; for others it’s a black box. But here’s the point. It’s not strategic transparency that is important; what is important is effective supervision by the relevant authority that the trades are genuine.

There was enough transparency for those who wanted to see to suggest that the Maddoff results were ‘too good to be true’. But despite this, investors flocked to him. Human nature being what it is, if someone (with an effective marketing network, reputation and charming personality) claims to produce exceptional returns, he will have investors flocking to him.

  • Does this mean I believe that hedge funds ought to be unregulated? It depends on what you mean by regulation. In my view, the government has a duty to protect its citizens from force, threat of force or fraud. If by regulation it is meant that an agency has the right to inspect a funds’ accounting and trade records, then I am all for it.

On the other hand, if by regulation we mean that sort of regulation that we have now, then I am against it. The regulation is far too complex, its codification of behaviour far too rigid. The aim of legislation should be to prevent fraud – period. Thereafter, the investor ought to be free to make up his own mind.

2 thoughts on “Regulation of Hedge Funds”

  1. Ray

    What is clear is there is no shortage of Nervous Nellies looking to pull the reins on traders, as pension funds and others pour cash into anything.

    All this fuss will not keep hedge funds from being able to freely experiment – with the blessings of their investors, probably.

  2. FYI

    MENTOR Ray Barros will be on:

    Monday 9th March at 12..00 to 12.15pm Hongkong Time (09.30 to 09.45am IST)- at Hongkong Studio.

    Show name is Pehla Sauda
    Anchors are Joyneel Mukherjee and Gaurika Chaudhery.

    Topic of discussion is overall Asian market and outlook of Global market.

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