Multi-Manager Hedge Funds Pose Financial Stability Risks, Bailey Warns
Bank of England Governor Andrew Bailey has raised concerns about the rising prevalence of multi-manager hedge funds, citing their potential to exacerbate market instability.
Correlated Activities and Risk Management
Bailey highlights the presence of correlated activities among multi-manager funds, which could lead to a rapid exodus of capital from these funds during market shocks. This is particularly concerning given that these funds often employ aggressive risk-management strategies.
Multi-manager funds, also known as multistrats or pod shops, have attracted a substantial portion of hedge fund investment flows in recent years. Their appeal stems from the promise of stable and diversified returns from independent trading units, or pods.
"Multi-manager funds can induce rapid deleveraging by individual pods during stressed market conditions, amplifying market fluctuations," Bailey stated in a speech at the University of Chicago Booth School of Business in London.
Impact on Prime Brokerage Capacity
Bailey also notes the growing scale of non-bank finance, which includes hedge funds, and its impact on prime brokerage capacity. Prime brokerage teams handle trades for large clients like hedge funds.
The concentration within this sector, following the Archegos collapse, has raised concerns about the adequacy of support during market disturbances.
Risk Management Benefits and Limitations
Bailey acknowledges that multi-manager hedge funds offer risk management advantages, with pods operating under a centralized umbrella risk management system. However, he cautions that correlations can still arise across different funds since multi-managers often pursue similar strategies.
Regulatory Scrutiny and Government Agenda
Regulators worldwide, including the Bank of England, are intensifying their oversight of non-bank finance activities. The BOE's System Wide Exploratory Scenario identified potential vulnerabilities among hedge funds and other buy-side firms during crises.
Bailey also challenges the UK government's deregulation plans, emphasizing that there is no inherent trade-off between economic growth and financial stability.