Rise of Multi-Manager Hedge Funds Poses Financial Stability Risk, Warns Bank of England Governor Andrew Bailey

Bank of England Governor Andrew Bailey has raised concerns about the growing popularity of multi-manager hedge funds, highlighting potential risks to financial stability.

These funds, often referred to as multistrats or pod shops, have attracted a significant portion of hedge fund investment flows in recent years, offering promises of diversified returns from distinct trading strategies or "pods."

Bailey expressed concern that correlated activity among these funds, coupled with aggressive risk management policies, could lead to a rush to exit positions during market shocks. "Multi-manager funds can make individual 'pods' deleverage rapidly in stress conditions, which can exaggerate market moves," he stated in a speech at the University of Chicago Booth School of Business in London.

Bailey emphasized that the growth in non-bank finance, including hedge funds, is straining prime brokerage capacity. He also noted that this sector has become more concentrated.

While acknowledging the benefits provided by the multi-manager hedge fund model, Bailey cautioned that correlation can still emerge across different funds as they are often attracted to similar strategies.

The Bank of England and other global regulators are closely monitoring the surge in finance activity outside banks. The central bank's System Wide Exploratory Scenario concluded in November that hedge funds, asset managers, and pension providers could be "underprepared" in times of crisis.

The Managed Funds Association, representing the alternative asset management industry, has expressed disagreement with Bailey's concerns. In a statement, MFA Head of Global Government Affairs, Jillien Flores, asserted that hedge funds enhance financial stability due to their lack of government backstops, liquidity mismatch, and isolation of losses to individual funds.

Despite MFA's perspective, regulators continue to scrutinize the rapid growth and potential risks associated with multi-manager hedge funds.