Greenspan warns hedge fund industry

ALAN Greenspan, chairman of the US Federal Reserve, has sounded a stark warning for hedge funds of difficult times ahead, saying the high-risk, high-return investors had already picked the 'low-hanging fruit' of easy profits.

Speaking today by satellite link to a bankers' conference in Beijing, Greenspan called on banks to manage lending risks to hedge funds to avoid widespread damage to the global financial system.

'After its recent very rapid advance, the hedge fund industry could temporarily shrink, and many wealthy fund managers and investors could become less wealthy,' he said.

'Continuing efforts to seek above-average returns could create risks for which compensation is inadequate. Significant numbers of trading strategies are already destined to prove disappointing, a point that recent data on the distribution of hedge fund returns seem to be confirming.'

Hedge funds, largely unregulated, have traditionally catered for wealthy individual and institutional investors, but the chase after higher returns by ordinary investors has seen their assets double over the past five years to around $1 trillion (£550bn).

Greenspan said low global interest rates had exacerbated the hedge funds' risks. In February, the Fed chairman said he found the low long-term interest rates 'a conundrum' and most explanations for them inadequate.

'One prominent hypothesis is that the markets are signalling economic weakness. This is certainly a credible notion. But periodic signs of buoyancy in some areas of the global economy have not arrested the fall in rates.'

He said stepped-up demand by pension funds for long-term assets was likely to be no more than "a small partî of the cause.

'Whatever the underlying causes, low, risk-free, long-term rates worldwide seem to be one factor driving investors to reach for higher returns, thereby lowering the compensation for bearing credit risk and many other financial risks over recent years,' he told the gathering in China.

The increased appetite for risk seemed likely to lead to losses, Greenspan said. 'But so long as banks and other lenders to these ventures are managing their credit risks effectively, this necessary adjustment should not pose a threat to financial stability.'

In other comments, Greenspan urged countries not to become resistant to free trade because it would lessen their economic flexibility.

'In this regard, the recent emergence of protectionism and the continued structural rigidities in many parts of the world are truly worrisome,' he said.