Hedge funds and Private Equity - PES

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– Funds of hedge funds (FOHFs) invest in a number of other hedge funds and are expected
to have lower volatility and attractive risk-adjusted returns due to diversification benefits.
On the grounds of the data provided by the TASS database, we can conclude that:
The role of hedge funds in the corporate field is relevant and has increased throughout the
last fifteen years. Long short equity, Event driven, Equity market neutral and Convertible Arbitrage
are strategies exclusively focused on corporate financial instruments like ordinary
shares, convertible bonds, corporate bonds and derivatives having the same instruments as
underlying asset. In aggregate terms these strategies represent approximately 60% of the
sector.
By now pure futures trading, generally based on technical trading system and the top-down
approach implemented by Global Macro, dealing with derivatives (option and futures on
equity indices or government bond baskets) are only a minor, almost marginal, sub sector of
the hedge funds industry.
The most recent trend prevailing in the industry is the aggressive growth of Multi Strategy
funds which try to diversify and swing dynamically, according to a direct disciplined risk
management approach, among different strategies.
Despite the differences of the strategies presented above, some common concerns must be
taken into account. There can be bandwagon effects due to the crowding of hedgee fund trades
using similar strategies entailing higher correlations of hedge fund returns with the extensive use
of leverage.
Also, some of the massive interventions of hedge funds on the market have clearly had a negative
effect on its functioning, as they don’t increase liquidity or contribute to price equilibrium,
thereby denying their so-called market-efficiency promoter role.
A tendency becoming clearer during recent years is that the differences between the traditional
fund management industry (incl. investment banks) and hedge funds seem to narrow. There is a
tendency to start using investment techniques similar to hedge funds.
1.5 Hedge funds and the banks – independent or shared interests?
In the debate on transparency and need for regulations of hedge funds, it is sometimes argued
that stronger demands on the banks over their credit analyses and demands on securities to
accept leverage loans to hedge funds will be an effective instrument.
This argument is of uncertain validity. Close analyses of hedge funds using leverage spread debt
look very similar to an investment bank.
A closer look at the importance of hedge funds for investment bank earnings confirms a further
interdependence. Hedge funds are very important counter parties for the sales and trading desks
in investment banking. The prime bookers of hedge funds are placed directly in investment banks,
providing the hedge funds with a bundle of services including transaction execution, financing,
securities lending etc.
Most importantly: The financial relationship between investment banks and hedge funds creates
credit exposure to the hedge fund industry and similarly, the counterparty risk from derivative
trading generates credit exposure to the investment banking sector.