Does anyone else have a problem with hedge funds, which create a large amount of volatility for everyone, only being controlled by a very few who can buy in? This is something which IMHO needs changing by legislation. I am open to valid counterpoints however. But when a very few can make life miserable for the masses, without the masses being the option of being able to buy into these same funds, there is in my mind an obvious ethical issue not being addressed.
Hedge funds stoke volatility in bear market
By Chelsea Emery
NEW YORK, July 28 (Reuters) - As traditional buy-and-hold investors flee the worst stock market in a generation, hedge have moved to the fore, deploying riskier and more exotic trading methods.
The result is a highly skittish market, prone to bursts of buying and selling that whip prices into sharp swings, according to traders and brokers.
Hedge funds "are the most active participants right now," said Bruce Turner, head of equity trading for CIBC World Markets. "When the market moves, they're behind it."
On Wednesday, for instance, the Nasdaq composite index (NasdaqSC:^IXIC - News) swung from a 3 percent loss in the morning to an almost 5 percent gain by the close of trading.
As the same time, the Chicago Board Options Exchange Volatility Index (CBOE:^VIX - News), also known as the "fear gauge," surged to 56.7 as early selling peaked. That was just a whisker off the reading of just over 57 at the height of the selling immediately after the Sept. 11 attacks.
"It's a heyday for short managers," said Robert Mitchell, who helps manage the $100 million Conestoga Capital Advisors hedge fund, which is up 8.7 percent for the year. "It's a great environment because we can hedge the market risk by going short."
Loosely regulated hedge funds can exploit a wide range of investment instruments, such as short selling and stock futures. Because they typically manage a few hundred million dollars, instead of mutual funds' billions, they are more nimble, and can place and unwind positions more quickly.
Staid mutual funds, on the other hand, are allowed to use only a few techniques and are constrained by their size and strict mandates -- such as investing for growth or value.
Hedge fund transactions account for as much as 50 percent of the daily buys and sells on the Chicago Board of Options Exchange, stock traders at top Wall Street firms said, compared with about 25 percent a year ago.
"In S&P futures over the last couple of months, probably 50 to 60 percent is hedge funds -- they've been coming in both ways to get into the market or get out. The volume has been phenomenal," said Rick Tobin, an S&P 100 options trader and chairman of the CBOE index committee.
The use of these instruments has gone up about 20 percent in the past year, Tobin said.
Traders also say as much as 40 percent of buy and sell orders on stock exchanges are placed by hedge funds.
Their influence is stunning, given that hedge funds hold assets of a mere $550 billion, compared with mutual fund assets of about $7 trillion, according to industry association data.
GAINS IN A DOWN MARKET
As stocks have tumbled this year -- the Nasdaq has lost a third of its value to touch a low not seen since 1996 -- hedge fund managers have used an array of tools to eke out gains. Many sell stocks short, meaning they borrow stocks in a bet they'll be able to replace those borrowed shares later at a lower price.
This technique, which is generally forbidden under the investment mandates for most mutual fund managers, has been especially successful as the market suffers through its worst period in nearly 30 years.
Also popular are the so-called Triple Qs (NYSE:QQQ - News) and Spiders (NYSE:SPY - News). These are funds that trade like stocks and represent shares in the Nasdaq 100 (NasdaqSC:^NDX - News) and S&P 500 (CBOE:^SPX - News) indexes, respectively.
The "QQQ" was the most actively traded security in terms of average daily volume in the first six months of this year because traders can make bets on market swings throughout the day.
These derivatives have helped many hedge funds avoid the Wall Street carnage. Funds, including those that concentrate on arbitrage and emerging markets, on average gained 1.4 percent this year, according to InvestorForce, which tracks hedge fund performance. Compare that with a 29 percent slide in the Standard & Poor's 500 index (CBOE:^SPX - News).
Yet, hedge funds have seen their share of losses. In June, funds tracked by InvestorForce slumped 1.1 percent.
"Right now, they are feeling the pain as much as everyone else is," said Jim Dunn, head of the alternative investment group at InvestorForce. "The challenge will be to see whether they can weather this storm well."
The rapid-fire trading tactics of hedge funds can push stocks lower quickly, leading some to blame market declines on the funds. But the same tactics can send indexes soaring just as fast.
"We must get away from the fact that somehow hedge funds have forced markets down to levels on the back of their short-term trading decisions," said Nigel Cobby, managing director of European equities at Deutsche Bank in London. "Equities have come down because, in the opinion of most investors, they are not attractive."
And when the market does turn sustainably higher, expect hedge funds to lead volatility to the upside as well, investors say.
"Hedge funds are momentum players -- they have their (computer trading) programs and, bang, they keep putting them in and it exacerbates the direction of the market," said Brian Finnerty, a strategist at money management firm Melhado, Flynn. "But that's why rallies are incredibly strong as well."
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