The collapse of many hedge funds in recent months has significantly tarnished trust among investors, but could ultimately result in a smaller and stronger hedge fund industry, a panel of fund managers said on Tuesday.

Speaking at a Toronto event organized by the Alternative Investment Management Association Canada, the managers said challenging times facing hedge funds will weed out weaker funds and result in a smaller industry that more effectively manages risk.

The hedge funds that survived 2008 were those who practised the strongest risk management, said Keith Balmer, manager of the Man AHL Diversified Fund. “They’re the ones who are going to survive, and they’re going to do very well in the years to come,” he said. “What you should be left with is actually fewer participants, which is going to give you more market opportunities, and more opportunities to play in a less crowded space.”

Managers who are too focused on short-term gains are also being separated from more successful industry players, according to Nandu Narayanan, a fund manager at Trident Investment Management LLC.

“If all you’re thinking about is yourself and not your investors, it is not a hedge fund that is going to survive. A lot of hedge funds, unfortunately, have demonstrated that that’s what they’re about,” said Narayanan.

The existence of such players in the field has had a negative impact on the whole industry, he added.

“It’s a very sad state of affairs in the whole business,” said Narayanan. “This has probably struck an almost irreversible blow to the industry overall. People are going to ask questions about what these managers really are and what the industry really is.”

The panelists agreed that more regulation for hedge funds is likely, which could help to boost investor confidence. But in many ways, regulation is not to blame for problems in the industry, the managers said.

For instance, the exposure of the Bernard Madoff scheme has highlighted the lack of due diligence being done by many managers and investors, according to Narayanan.

“This was actually an abject failure of the people that sold the fund, that invested in it, to do even the basic due diligence,” he said. “It was not a failure of regulation.”

Furthermore, regulation can only go so far in protecting investors. Narayanan said most of the recent losses in the industry simply result from poor investment decisions by managers with previously strong track records.

“You can’t regulate morality or ethics or competence in management,” he said. “There’s only so much that a regulator can do and there’s only so much transparency can do.”

Balmer agreed that new requirements for hedge fund transparency would not change the significant risks involved with hedge fund investing, and would not necessarily make investors feel safer.

But John Clark, CEO of alternative investment firm JC Clark Ltd., argued that transparency would have immediately exposed the scheme behind Bernard Madoff, and therefore does have an important role to play.

Clark expects the regulatory environment to change substantially in the United States in the next year, including an entirely new regulatory body

“I don’t think there’s any hope that you’re going to have an SEC in a year’s time,” Clark said. “It will be a new body, it will have a new mandate and it will be staffed differently.”

But if the regulators act too quickly and too impulsively to impose new industry rules, they could ultimately cause more harm than good, Balmer said.

“When you’re very, very close to a problem or a crisis, it is exactly the wrong time to start changing the rules,” he said. It would be more effective to regulators to wait at least six months before assessing the problems underlying the crisis, Balmer added.

IE