Hedge funds facing the chop

UP to 1,600 hedge funds will go bust over the next two years, possibly triggering a stock market crash. As rumours sweep the City that several are in trouble after a series of big bets went badly wrong, the Centre for Economics and Business Research reckons the 10% annual failure rate among the 8,000 funds will be maintained.

'We predict a further 20% of hedge funds will close over the next two years, since economic conditions are likely to be at best average for the funds,' said CEBR chief executive Doug McWilliams.

'In theory, this could act like a big bank going bust and trigger a series of knock-on failures worldwide and a stock market panic.'

A wave of collapses would see central banks slashing interest rates to prevent a credit crunch. That is precisely what happened in the autumn of 1998 when the Federal Reserve took the knife to US rates to head off panic over the failure of Long-Term Capital Management, a US-based hedge fund into which major banks and investors had poured large sums.

But there is a danger panic could grip markets faster than central banks could act. 'We do not think that this is the most likely outcome. But fear of it happening is one reason why we expect interest rates worldwide to be rather lower over the next two years than is the consensus,' said McWilliams.

The hedge fund industry is already in turmoil after unprecedented losses in recent weeks. Rough estimates suggest it is 8% poorer today than three months ago, although some funds are much worse off. Sources close to the industry revealed today that London-based Cheyne is down by about 5% while Ferox, also based here, is said to be nursing losses of 7%.

Major banks are unlikely to have been immune and Deutsche Bank has seen its shares dive on unsubstantiated fears that it has bankrolled hedge funds. The biggest blow came earlier this month when Standard & Poor's downgraded General Motors and Ford bonds to junk levels, and US investor Kirk Kerkorian seized the opportunity to buy shares. Bond prices fell and share prices rose, the opposite of what fund managers thought would happen.

Getting to the bottom of this media-shy industry is hard. But Warren Spencer, president of Bear Stearns, a leading broker for the industry, said this week that fears were overblown.