Global Hedge Fund Alert!

The New York Federal Reserve gave an alert on accumulated risks created by the growing Hedge Funds. They concluded that this could be the biggest threat to the financial world since the fall of LTCM (Long term Capital Management). LTCM was a Hedge fund founded on the shoulders of mathematical / Economic geniuses, Robert C. Merton (and Myron Scholes (who won Nobel Prize in 1997.

LTCM took full advantage of leverage and used its size to create a huge diversified portfolio. During the 1998 economic turmoil their funds lost the diversification advantage and this resulted in a highly correlated portfolio. In the end within months the whole fund collapsed and in the end the Federal Bank of New York had to step in with support of close to $ 4 billion to stop a “systemic fall” of the financial markets.

The Federal Reserve of New York compares the current scenario of Hedge funds with the LTCM crisis. The Hedge funds are showing a huge correlation in their returns, predisposing the markets to a “systemic downfall.” The total size of the Hedge funds now stands at $ 1.4 trillion, larger than many economies of the world. The funds are now betting aggressively with fewer strategies and by taking higher leverage through use of derivatives.