Posted on 06/28/2004 3:26:21 PM PDT by take
U.K. central bank sounds warning Central bank worries hedge funds taking same strategies
LONDON (CBS.MW) -- The Bank of England, one of the world's most closely watched central banks, and Man Group, the largest publicly traded manager of hedge funds, are located not even a mile away in London's financial district, but their views are a galaxy apart.
Their varying viewpoints were reinforced Monday, when the Bank of England warned that hedge funds, such as those operated by Man (UK:EMG: news, chart, profile), are a threat to market stability, on the same day the fund manager said it had raised nearly three-quarters of a billion dollars to run more speculative money.
Andrew Large, Bank of England deputy governor, said "the search for yield" by hedge funds and other investors has hit financial stability.
"If a 'search for yield' has seen market participants adopt similar trading strategies, a change in economic conditions could trigger sharp asset price movements or market liquidity problems if investors simultaneously try to unwind common positions," he said in a statement on the central bank's Financial Stability Review.
It noted hedge-fund flows have increased rapidly, investment banks have taken on greater proprietary trading risk, insurers in various countries have moved down the credit spectrum to maintain nominal returns, and the issuance of structured notes with embedded options remained robust, particularly in Europe and in Asia.
With typical British understatement, the central bank wryly noted that "many [institutions were] no doubt disciplined by effective risk management" in taking on the enhanced risk profile.
The rates trend
The Bank of England, which has aggressively moved to hike interest rates, is wondering what will happen as it continues its rate-hiking plan, the Federal Reserve embarks on its rate-hike program and other central banks begin to mull rate rises.
"In particular, it is unclear whether there might further substantial adjustments to portfolios as and when official interest rates rise and, if so, how smooth they might be. In part that will depend on the extent of leverage in the system the particular circumstances in individual markets," the bank said.
It pointed out that since its last review, in December, there have been exceptionally large fluctuations in speculative U.S. dollar positions, in part on carry trades that seek to take advantage of borrowing in low-rate environments and also on Japanese central bank speculation. It added that low short-term nominal interest rates and fairly steep yield curves may encourage some to keep those carry positions.
The bank took note of the potential "that the widely increased use of electronic trading platforms may have created a misleading impression of the depth of liquidity that could be assured in stressed conditions," the bank said.
It added that interest-rate hedges on mortgage-backed securities are "unlikely" to be perfect, arrangers of bank loans are placing "more aggressive deal structures," and high-yield issuance has, until recently, been very active.
And it pointed to another risk: that the sheer scope of the growing hedge-fund industry is eroding arbitrage possibilities, so investors may react with sizable withdrawals.
"Contacts typically suggest that there is now greater risk of stress from many funds tending occasionally to be similarly positioned than from a single large fund failure," the central bank said.
Man's rise
At Man Group, the picture looks markedly different.
The group last month reported a 48 percent jump in assets under management for the year ending March 31, which led to a 29 percent rise in net performance fee income and a 46.3 percent rise in pretax profits.
Its fiscal 2004-05 prospects were also solid, it said. "Appetite for our fund products remains strong," it said.
Indeed, on Monday Man said it has raised another $705 million for two new, diversified hedge funds.
"There continues to be strong demand for Man's products that can add diversification and enhance the risk/return profile of investors' existing portfolios," the company said in a statement.
Man has seen a 70.9 percent share-price gain since the start of 2003.
A Man Group spokesman said he had yet to see the Bank of England report, but an analyst who follows the company, Stuart Duncan of broker Numis Securities, said asset withdrawals are not seen as much of a concern at this point.
"Man's view, and the view of others, is that they still expect huge growth in coming years as institutions and pensions realize they're underweight as an asset class," Duncan said. "There's a lot of growth potential."
Duncan said capacity to handle the inflows is an issue, but Man has thus far handled them with timely acquisitions.
Steve Goldstein is a reporter for CBS MarketWatch.com in London.
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