Effects on Global Economy

The continued growth of hedge funds, both in number of active hedge funds and investment funds they manage, is an issue that confronts public policy decision makers. The U.S. Senate Judiciary Committee had conducted hearings for the purpose of bringing hedge funds under some degree of monitoring and regulation but this has been successfully challenged in court by a hedge fund manager. The U.S. Securities and Exchange Commission tried to make hedge fund managers register with the SEC for monitoring purposes (not the funds, but their managers) but was overturned by an appeals court. The SEC’s purpose was to detect irregular trading patterns such as adopting a skewed trading strategy that does not reflect true risks and gives consistently false higher returns before blowing up. These irregularities concern the SEC as it can potentially harm individual investors (individual persons or institutions), threaten stability of the hedge fund industry, and undermine global financial markets.

Even the American president has created the “President’s Working Group” or PWG a year ago precisely to address these concerns. Hedge funds escaped attempts at regulation by citing increased government regulations will stifle their flexibility and innovation. What the PWG recommended instead was a set of vaguely-worded voluntary non-binding principles for hedge funds to adopt. In effect, what the PWG did was throw back the issues to the hedge fund industry and let them regulate themselves. It seems the present administration’s strong anti-regulatory mindset was reinforced by the new wealth and political power of the hedge fund industry which many suspect contribute to political campaigns. These blunted efforts of pro-regulation lobby groups who claim ordinary investors are nonetheless exposed to the same risks indirectly because of investments made by their pension funds and also personal retirement accounts.

A new and rarely discussed risk is that hedge funds create a big incentive to show big profits one year (to qualify for the incentive fees) and then show losses the next succeeding year (dissolve the fund, create a new fund, and then purchase again all those cheap assets and make a nice bundle). The hands-off approach of the working group showed the influence of the hedge fund industry into the highest levels of government decision-making, arguing successfully that regulations will deter lightning-fast trades by hedge funds and even compromise both their trade positions and investment strategy by allowing competitors to imitate or copy them.


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