Hedge funds and Private Equity - PES

4. Employees, pension fund investments
and long-term real value
Although we have seen earlier in the report that a certain “retailisation” is underway, the added
value that hedge funds bring to retail consumers is questionable, while the development of the
market introduces significant risks (see below). Although a strong consumer policy case could
be made (based on the precautionary principle) for a prohibition on the distribution of hedge
funds (and similar asset classes) to retail investors, it is probably not politically viable, given the
current emphasis on market liberalisation within the EC. However, it is certainly reasonable to
argue for a set of robust regulatory interventions to manage the potential detriment to retail
consumers. The sentiments expressed in the Commission expert group report that further liberalisation
would result in improved consumer welfare need to be challenged by objective
commentators.
If the EC genuinely believes that hedge funds do have something to offer retail investors and is
keen to see the market develop, then consumer confidence is paramount. It goes without saying
that a hedge fund scandal similar to those seen in the US would undermine the limited potential
for the sector and damage the reputation of EU policymakers.
To be fair to the Commission expert group, it does make some consumer protection recommendations:
a minimum investment threshold of Euro 50,000 and for the enforcing of clear
conduct of business requirements on the intermediaries and institutions who conclude sales
contracts with end-investors.
These measures provide only limited protection – for example, the minimum investment threshold
could easily be circumvented in cases of large pension transfers. However, the main flaw in these
recommendations is that they do not sufficiently address the numerous key risks such as: legal
and governance issues, prudential supervision, conflicts of interest within the hedge fund system,
valuation risks, disclosure, promotion and marketing issues, intermediary competence, and risk
classification.
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Alternative investment funds in the form of structured products have the potential to offer ordinary
retail investors a product which offers a return on the risk spectrum between bonds and equities 50 .
Alternative investments offer pension fund trustees opportunities for gaining exposure to alternative
asset classes and diversifying risks. So there could be considerable potential benefits for
consumers if the market operates properly and the present report does not aim to obstruct the
development of functioning, efficient markets. The objective of this report is to ensure that the interests
and structure of the market are aligned with the interests of consumers and wider society.
The main claims made by advocates of hedge funds are that: they can deliver superior returns and
they offer enhanced opportunities for diversifying portfolio risk. These claims are open to challenge.
To begin with, a general point is that while hedge funds have developed a certain ‘mystique’ they
are in practice simply another form of active investment management, which seeks to add value
by taking a position in the market. There is no guarantee that a hedge fund strategy will deliver
superior returns – as with any active management strategy it will depend on the skill but mostly
the luck of the fund manager involved. And much of the available historical evidence suggests
that past performance of a fund is of limited use as a predictive indicator of future performance.
50 As a replacement for the with-profits type investments offered by insurance companies.
Part II – Six concerns about our European social market economy
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