Where there’s volatility, there are typically critics who seek to blame it on hedge funds. Look no further than Asia, whose equity markets have a long history of hair-raising twists and turns, such as the recent sell-off that shaved nearly 9 percent off the Shanghai composite index in a single day.
Traders and regulators attribute the ferocity of this year’s selling spree to an influx of foreign hedge funds, which today account for one quarter of the region’s trading volume, up from just 5 percent in 2005, according to Greenwich, Connecticutbased consulting firm Greenwich Associates.
At a recent conference, Reserve Bank of India governor Yaga Venugopal Reddy noted that events in Asia “have reinforced the possible adverse impact of [hedge funds].” The country is so worried about hedge funds that new funds must now register with India’s national regulatory agency, the Securities and Exchange Board of India, instead of permitting the funds to gain access to Indian markets through participatory notes, which allow them to keep their holdings private.
Of course, blaming hedge funds for Asia’s market instability is hardly a new idea. At a meeting of the International Monetary Fund ten years ago in Hong Kong, Asian officials denounced hedge funds that speculated in currencies as enemies of central banks and the leading cause of the region’s volatility. The confab culminated in a shouting match between billionaire investor George Soros and former Malaysian prime minister Mahathir Mohamad, who famously called the macro hedge fund manager a “moron.”
Much has changed since then -- the key difference being stronger Asian economies that are attracting longer-term investors. A decade ago Western investors profited from short-term trades that capitalized on shaky economies and markets. Today the region boasts stronger fundamentals and solid currencies, fueled by urbanization and a growing middle class. That should make Asia an attractive, stable place in which to invest for the long haul.
“In 1997, U.S.- and Europe-based institutions took advantage of the fragility of Asian economies and financial markets,” says Frank Brochin, a partner and managing director of New York hedge fund StoneWater Capital. “Today, the situation is vastly different.”
Hedge funds may in fact be a stabilizing force in the region. In addition to boosting overall trading volume and commission payments, hedge fund activity is having a positive impact on Asian sell-side strategies by adding liquidity to the market and making it easier for brokers and market makers to efficiently serve their clients, according to a recent report by Greenwich Associates.
Alain Reinhold, executive vice president and a member of the executive board at Paris-based ADI Alternative Investments, argues that hedge funds help bolster regional economies and can militate pullbacks because their strategies usually are not correlated with market indexes. And because hedge funds rely almost exclusively on electronic trading, he says, they’re helping to make the markets more efficient for all participants.
Timothy Condon, chief economist and head of Asia research for Amsterdam-based ING Group, says analogies to 1997 are misplaced. “I think it would be a mistake to ascribe to hedge funds too great a role for the appreciation in risky asset prices or in the recent market sell-offs,” he explains. “The substantial liquidity that hedge funds provide has to go somewhere. If they were banned tomorrow, their funds would move to other investors. There would be no change in the upward pressure on risky asset prices.”
