http://www.economist.com/finance/displaystory.cfm?story_id=12381701


An industry suffers, and regulators have not helped

HEDGE funds are supposed to hedge. This year, they haven't. The 
fund-weighted composite index compiled by Hedge Fund Research, a firm that 
tracks the industry, fell by 4.7% in September, the second-worst month on 
record. Since the start of the year it has lost 9.4%. The industry's 
promises of "absolute returns" for investors now ring rather hollow.

To be fair to them, hedge funds have not been allowed to hedge. The 
restrictions on short-selling (betting on falling prices) imposed by 
regulators round the globe have played havoc with managers' strategies in 
recent weeks.

Take the worst-performing strategy, convertible arbitrage, which lost the 
average fund 12% in the month. Convertible bonds are fixed-income securities 
that can be exchanged for shares in the issuing company. Historically, these 
bonds have been underpriced, because too low a value has been placed on the 
right to convert them to equity. So arbitrage managers have tended to buy 
the bonds and sell short the shares. Thanks to the Securities and Exchange 
Commission's ban on the shorting of more than 900 stocks from September 19th 
to October 8th, that strategy no longer worked. And since the managers could 
not short the shares, they had to sell the bonds. As a result, the bonds' 
prices plunged.

Perversely, issuing convertible bonds would have been one way for banks to 
raise capital. But that route has been cut off, a typical example of the 
unintended consequences of meddling with the markets in response to populist 
pressures. 

-- 
http://www.piclist.com PIC/SX FAQ & list archive
View/change your membership options at
http://mailman.mit.edu/mailman/listinfo/piclist