Academic

Rogue Hedge Funds?

By Kim Krawiec

The rogue trader story is one that is now all too familiar.  A trader appears to be making phenomenal profits, garnering respect, high bonuses, and power within the financial institution.  Eventually, it is revealed that the profits are illusory, the trades are fakes or losers, and the trader has gotten himself, and maybe his firm, into deep ? sometimes, irreversible ? trouble.  Often the downward spiral began with losses ? sometimes small ? that the trader tried to make up through riskier positions.  Think Jerome Kerviel at Société Générale, Nick Leeson at Barings Bank, or Joseph Jett at Kidder Peabody. 

Now imagine what a hedge fund manager might do if facing similar trouble.  According to Rick Bookstaber, the same thing: 

If he follows the same course as the trader at the bank, he will try to find ways to take on more risk. Of course, any investment fund might face the same temptation, but hedge funds have more tools at their disposal to make good on the try. Hedge funds can lever, delve into wide-ranging and risky markets and readily employ the so-called innovative securities to increase risk in ways that are difficult to discern. And unlike the trader at the bank, the hedge fund can operate without anyone seeing what it is doing. No one is looking over its shoulder at the trading positions each night.

Bookstaber closes with a list of the seven habits of highly suspicious funds that investors should watch out for. 

(HT: Felix Salmon)

Full post as published by The Faculty Lounge on June 23, 2009 (boomark / email).