Updated from 3:05 p.m.The hedge fund industry argued Thursday against charges that its investment strategies cause market upheaval and put small retail investors at a disadvantage. During a conference held by the Securities and Exchange Commission to help determine whether hedge funds warrant more regulation, panelists argued that the risks present in the market aren't necessarily related to the strategies employed by these funds. Much of the market volatility comes from individual investors' behavior, the panelists said. Risks, they said, can be mitigated by investor education rather than regulation. Skittish and uninformed investors are more likely to roil the markets than hedge funds are, the panel argued. Hedge funds aren't subject to the same strictures that regulate mutual funds and other retail investments, as hedge funds are generally excluded from the definition of "investment company" in the Investment Company Act of 1940. To be excluded from that category, hedge funds must have 100 or fewer investors, or require that investors meet certain minimum standards in terms of investible assets and annual income. But those minimum standards were set some 20 years ago, and thanks to inflation and the recent bull market, far more "average" investors are able to invest in hedge funds than originally intended. The broader investor base, as well as some spectacular hedge fund failures, prompted the SEC to launch a formal fact-finding investigation of the industry a year ago. This week's two-day conference is supposed to provide information that the SEC can use to determine if more regulation is warranted.
William Heyman, chief investing officer of the St. Paul Companies, added, "Risk is like energy. It can change form but it can't be eliminated." To further the advocates' argument, Peter Brown, executive vice president of Renaissance Technologies, compared hedge funds to stocks. "The median volatility of hedge funds is half that of stocks," he said. "The median volatility of a fund of hedge funds is one-quarter that of the S&P 500. Using an objective measure of risk, hedge funds are less risky." Indeed, while hedge funds emerged from the dot-com bubble relatively unscathed, mutual funds took the hardest hit. "This is one of my favorite statistics. Eighty-five percent of all the money in technology mutual funds came in after January 2000," Heyman said. In other words, investors made a bad move, and they might benefit from access to the tactics employed by hedge funds, because the managers have a plethora of strategies to exploit market inefficiencies. The panelists argued that regulation won't minimize hedge fund disasters, which are generally thought to agitate the markets. "Most blowups are operational issues and could be prevented by auditors," said Lawrence Harris, chief economist and director of the SEC's office of economic analysis. "We should be able to rely on an intermediary such as the accounting profession to provide some risk-control measures."