Taking the rough with the smooth

Another change being debated is the impact on the liquidity of hedge funds. With hindsight it is obvious that many of the problems seen in the financial industry today are the result of a liquidity mis-match. On the one hand we see calls for a reduction in liquidity, following the private equity model and removing the issues of mark-to-market accounting on illiquid or hard-to-price securities. On the other hand, investors demand for liquidity has increased. For the most part, hedge funds have offered very similar liquidity terms, regardless of the underlying strategy. Hedge fund investors are in a stronger position now than ever before to demand appropriate liquidity terms. In the future it is likely we will see an improvement in liquidity from liquid strategies combined with reduced liquidity from those strategies that rightfully demand it.

The changes to the environment are certainly not all negative. Hedge funds are now facing substantially reduced competition. The proprietary trading desks, once hedge funds largest competitors, have substantially reduced assets and have withdrawn from some strategies all together. This, combined with reduced gross assets from hedge fund themselves creates an improved opportunity set for the funds that do survive. After a difficult adjustment period, we believe that the improved playing field should prove beneficial for hedge funds and their investors.

Kate Brown is a portfolio manager on the investment team for SG Hambros

Source: Bloomberg, Hedge Fund Research Inc. - © 2008 HFR Inc.