Wednesday, May 17, 2006

Hedge fund follow-up

Two additional articles that you might enjoy on hedge funds (see yesterday's entry)

1. From GreenTrader(via

How to Set Up Your Own Hedge Fund:
"Traders and money managers often dream about one day running their own hedge fund, managing large sums of money, and competing head to head with the world's top traders. For many, though, this dream remains unfulfilled, because they do not know where to begin and do not want to squander their resources “reinventing the wheel.”
and later:
"The first step toward setting up a hedge fund is getting a better grasp of what exactly a hedge fund is. Hedge funds often are compared to registered investment companies, unregistered investment pools, venture capital funds, private equity funds, and commodity pools....Unlike a mutual fund, a hedge fund is not registered as an investment company under the Investment Company Act and interest in the fund is not sold in a registered public offering. Hedge funds can trade in a wider range of assets than a mutual fund. Portfolios of hedge funds may include fixed income securities, currencies, exchange-traded futures, over-the-counter derivatives, futures contracts, commodity options and other non-securities investments."
Read the entire thing here. It goes on to show also who is an accredited investor (and hence can invest in hedge funds). Good stuff!

2. The second "item" is from Fed Chairman Bernanke's speech on systemic risk and hedge funds. A rather long "look-in":
"The primary mechanism for regulating excessive leverage and other aspects of risk-taking in a market economy is the discipline provided by creditors, counterparties, and investors. In the LTCM episode, unfortunately, market discipline broke down....

The Working Group's central policy recommendation was that regulators and supervisors should foster an environment in which market discipline--in particular, counterparty risk management--constrains excessive leverage and risk-taking. Effective market discipline requires that counterparties and creditors obtain sufficient information to reliably assess clients' risk profiles and that they have systems to monitor and limit exposures to levels commensurate with each client's riskiness and creditworthiness....

For various reasons, however, creditors may not fully internalize the costs of systemic financial problems; and time and competition may dull memory and undermine risk-management discipline. The Working Group concluded, accordingly, that supervisors and regulators should ensure that banks and broker-dealers implement the systems and policies necessary to strengthen and maintain market discipline, making several specific recommendations to that effect. The Working Group's recommendations on this point have largely been followed....

An alternative policy response that the Working Group considered, but did not recommend, was direct regulation of hedge funds. Direct regulation may be justified when market discipline is ineffective at constraining excessive leverage and risk-taking but, in the case of hedge funds, the reasonable presumption is that market discipline can work. Investors, creditors, and counterparties have significant incentives to rein in hedge funds' risk-taking. Moreover, direct regulation would impose costs in the form of moral hazard, the likely loss of private market discipline, and possible limits on funds' ability to provide market liquidity.

The speech was given yesterday.

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