HEDGE FUND? BOON OR BANE

Whenever the word “Hedge Fund” comes to our mind it gives a sense of shock and awe among most players in the Indian market. What is it that gives these funds such an aura?

Hedge funds come into the limelight whenever the markets go into an overdrive, either upward or downward. Hedge funds are pooled investment vehicles whose investment in publicly traded securities is huge as compared to average investors. India is one of the favorite destination for hedge funds. They have generated a much higher return from emerging market portfolio compared to their returns on the average global portfolio.

Hedge funds boost speculative trading into the market as the small institutional investors have to book profits because they are paranoid of a sudden sell off by hedge funds. Moreover to match the returns generated by hedge funds small inventors will adopt the high risk-high reward strategy. The worry is that they may not yet have adequate expertise and experience compared to hedge funds.

The common perspective about hedge funds is that they bring too much volatility into the market. Many developing economies have faced financial turbulence because of hedge funds. Hedge funds are held responsible for the South East Asian crisis. Hedge funds can cause swings in values and prices of currencies, stocks and interest rate.

Hedge Funds have been a major concern for regulators across the globe as they increase market volatility and occasionally, they have caused entire economies to crack under the weight of their selling. In Indian capital market one of the major reasons for volatility are hedge funds. Hedge funds are a double-edged sword as they are momentum players who escalate the possibility of a financial crisis.
However, one of the pluses of hedge funds is that they provide a lot of liquidity to the market, and thus enhance the price discovery mechanism at the bourses. While their operations do result in unlocking the potential value of stocks, it is normally only in the short term.
At present, hedge funds cannot invest directly in the Indian markets. However, they could invest through Participatory notes issued by SEBI-registered FIIs .According to RBI with greater risk aversion going forward, with credit quality deteriorating and with the widening of credit spreads, the potential fragility of hedge funds could pose significant risks to financial market stability and to the prospects for financing and growth in the emerging market economies. Therefore in a move to curb down the volatility caused by hedge funds in the capital market SEBI has asked hedge funds investing through sub account to register themselves as FII as it will increase transparency in their operation.
Is there any advantage in allowing hedge funds to participate in the Indian stock market? In an open market system like ours one can't wish away hedge funds and the bottom-line is that there is no escaping from them.

... Hrishikesh Sahay