The Hindu Business Line : Hedge funds: Are their days numbered?

THE much-hyped mystery over hedge fund investing in Indian equity market through participatory notes (PNs) may be over. Officials at top broking firms feel that hedge funds cannot invest in the stock market after February 3,as PNs can be issued only to regulated entities.

Hedge funds are basically private investment pools for wealthy, financially sophisticated investors. Traditionally, they have been organised as partnerships, with the general partner (or managing member) managing the fund's portfolio, making investment decisions, and normally having a significant personal investment in the fund.

They use sophisticated investment strategies resulting in sharp gains and losses on their investment. This also leads to volatile movement of the markets where they invest.

However, there is still no official communication from SEBI, whether hedge funds can invest or not except that PNs against underlying Indian securities can be issued only to regulated entities.

But stockbrokers said since hedge funds are not regulated in their home countries they cannot invest in India.

According to the National Association of Securities Dealers (NASD), the body regulating the securities industry in the US, hedge funds are usually not required to register with the Securities and Exchange Commission (SEC) so they do not provide many of the investor protections that apply to registered investment products, such as mutual funds.

According to Investment Company Institute (ICI), a national trade association representing mutual funds, unit investment trusts, and closed-end funds in the US, hedge funds are exempt from regulation by the SEC under the federal securities laws, with the exception of anti-fraud standards.

Brokers said the SEBI clarification that came after the closure of the market on Friday, appears to be very positive but one could see sharp volatility in the market in the next few months.

This is due to the short-term perspective of the hedge funds. "No hedge fund will like to remain invested for five years, so one could see heavy selling by them in the next few months," said a top official of a stock broking firm.

According to market sources, around Rs 15,000-16,000 crore of FIIs investment in 2003 would have come through PNs and of this, around Rs 6,000-7,000 crore has come through hedge funds.

Another fear of the market is that hedge funds have invested in various mid-cap and small cap companies and there is a possibility of sharp fall in the stock price of these companies.

An official of a foreign broking firm said, "Mid-cap stocks that have seen sharp rise in the FIIs holding could be severely affected".

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