As the US Federal Reserve hikes interest rates closer to 5 per cent, investors can get equitable returns from cash without taking any risk, ...

As the US Federal Reserve hikes interest rates closer to 5 per cent, investors can get equitable returns from cash without taking any risk, admitted delegates at a hedge fund conference in London yesterday. This makes it difficult for hedge fund managers to justify their fees, said the delegates at the Tara Capital Hedge Fund Strategy conference, which featured heavyweight investors including Florian Homm, the chief investment officer of Absolute Capital Management, and other prominent hedge fund investors. “Six weeks ago we did not believe that the Fed would be pushing interest rates to 5 per cent. There is still a lot of denial out there. Fund managers believe that as long as they do not under-perform their peers everything will be fine,” said one delegate. “Things can now easily come unstuck. Look at the state of Merrill Lynch bond offerings – these have hit an all time low,” he said. One approach would be to double up leverage; to double one’s risk in search of better returns, said one speaker. However, delegates at the conference agreed there was a fundamental “disconnect” between the data out there and anecdotal evidence, which better describes what is really happening. Portfolio insurance was also discussed as prudent move, amid the hype surrounding stellar initial public offerings and high bonuses, among European and American hedge fund managers. “There is the 1 per cent chance of ‘toxic waste’ within a fund that managers simply hope will not ever hit the wall,” noted another delegate. In a high interest rate context, collateralised debt obligations were mentioned, in terms of their potential toxicity. CDOs are structured fixed income securities with cash flows linked to the performance of debt instruments, carrying the risk of various maturity and credit risk characteristics. “These are out there and as interest rates go up they are not going to do well. You don’t get lots S&P warnings for instance. In fact the only option left to unwary pension funds exposed to CDOs is to sue,” said one hedge fund panel member.