Hedge Funds May Be Less Risky Than Thought: U.S. Treasury Analysis

Everyone, or at least much of theinvesting public, knows that hedge funds are risky investments, right? Well, the U.S. Treasury Department’s new Office of Financial Research has preliminarily concluded that this conventional wisdom may be off-base.

In remarks at the Brookings Institution last week, OFR director Richard Berner reported preliminary findings based on data from some 6,000 hedge funds.

Berner said that hedge funds with the highest leverage had less than 5% of hard-to-value assets in their portfolios, while those with no leverage contained about 20% of such assets. He emphasized that “this is a tentative conclusion, but one that probably bears further investigation.”

In addition, the OFR analysis examined whether a given fund calculated value at risk, and found “not a crystal clear relationship,” but one “suggestive of the idea that funds with higher leverage were somewhat more likely to calculate value at risk.”

Finally, Berner said, the data showed that on average, funds that reported higher levels of value at risk also tended to report low leverage. But he added, “We can’t put too much weight on this result without alternative measures of portfolio risk to confirm it.”

The OFR gained new access to hedge fund data after the 2010 Dodd-Frank Act required certain large private funds to submit confidential information to regulators, in an effort to help them better police for systemic risks. The Office of FInancial Research itself was created by Dodd-Frank, and Berners has served as its first and only director since January 2013.

The Managed Funds Association, which mainly represents hedge funds, welcomed the OFR’s analysis, tentative though it was, Reuters reported. The MFA’s president and chief executive Richard Baker said the analysis “largely confirms the history of data on hedge fund strategies and their use of leverage, and tracks with MFA’s view that hedge funds currently do not pose a systemic risk.”

Reuters reported that Berner stood by a September report his office had produced that focused on risks posed by highly regulated mutual funds, but did not contain data or analysis on less-regulated hedge funds, upsetting mutual funds. Berner said the prior report did not include such data because regulators had only recently started to collect information and did not yet have a clean data set.

Reuters said the research was expected to help a U.S. panel of regulators decide whether to designate larger asset management firms as systemically important, thus requiring them to set aside more cash and face heightened oversight by the Federal Reserve.

Since the report was released, Reuters said, the industry and some members of Congress have said it was poorly informed and fundamentally misunderstood asset managers’ business models and how they differ from those of banks. Privately, regulators at the Securities and Exchange Commission, which oversees asset managers, have also contested the report, Reuters reported.