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Hedge fund fallout
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September 28, 1998: 9:27 a.m. ET
LTCM bailout has raised regulatory concerns about hedge fund oversight
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NEW YORK (CNNfn) - The effects of last week's $3.5 billion bailout of Long-Term Capital Management, a prominent U.S. hedge fund, continue to ripple through the financial community, leaving investors scrambling to assess the extent of damages and regulators calling for greater oversight of the industry.
So far, however, there appear to be more questions than answers.
Convergence Asset Management, a bond arbitrage fund headed by former Salomon Brothers superstar Andrew Fisher, warned investors Friday that the value of the fund is down 15 percent to 20 percent for the month and 30 percent for the year, the Financial Times of London reports.
Fisher said in a letter to investors that "hurricane Long-Term blew through our markets with such force that many were left homeless. While our house lost shingles and windows, we're still here."
He reportedly added the fund's already bleak bottom line could get worse before it gets better.
LTCM, of Greenwich, Conn., is a private hedge fund started in 1994 by another former Salomon Brothers trading legend, John Meriwether.
A consortium of major commercial and investment banks -- including Goldman Sachs, Merrill Lynch, Morgan Stanley Dean Witter, Travelers Group and UBS Securities -- agreed last week to provide the fund with a $3.5 billion equity infusion to save it from liquidation. The bailout raises the fund's net asset value to more than $4 billion.
While the equity infusion helped ease investor concerns, it did little to reassure regulators across the globe that hedge funds aren't in need of closer oversight.
Hedge funds, investment pools commonly used by the wealthy, currently are unregulated. Some say the LTCM crisis will cause regulators at home and abroad to introduce investor protection legislation. Likewise, they say, it may cause banks to rethink their lending policies to hedge funds as a whole.
Federal Reserve Board Chairman Alan Greenspan and New York Fed President William McDonough are scheduled to testify this week before Congress on the risks of hedge funds and the near-collapse of LTCM.
At the same time, Britain's Financial Services Authority has asked 55 financial companies to provide information about their exposure to LTCM and other hedge funds. And Daniel Zuberbuehler, the Swiss Bank Commission director, reportedly has requested a formal government investigation into the matter.
The economic crisis in Russia, Asia and Latin America has plagued banks and hedge funds alike, making it difficult to tally the losses.
Hedge funds have lost huge sums of money by buying emerging market bonds, particularly Russian bonds, and hedging them with short positions in government bonds of more stable G7 countries, such as the United States.
Some funds have been hit on both ends, as emerging market bonds plunge and the price of U.S. Treasuries ramps up.
Last week, Switzerland's UBS AG, Europe's biggest bank, cited global market turmoil for an expected slide in its third-quarter net income. UBS said it anticipates an after-tax loss in the third quarter of $360 million to $716 million.
The bank also warned it would take a nearly $700 million charge to write down the value of its previously undisclosed 15 percent equity stake in the fund.
The disclosure prompted Dresdner Bank AG of Germany to warn its investors of an expected $143 million loss from its investment in LTCM.
Dresdner Bank, however, said it won't lose money on its investment because of profits made earlier from the fund, according to reports.
Analysts say the economic volatility that has rocked world markets, and the resulting losses in the banking and investment sectors, underscores the importance of maintaining a diversified portfolio.
Carrie McCabe, with the alternative investment adviser Blackstone Group, said that doesn't mean investors should avoid hedge funds entirely. It just means they shouldn't place all their eggs in one basket, she said.
"What this really shows in the marketplace is that a varied hedge approach is absolutely essential to investing in hedge funds," she said. "It is imperative that you don't place all your money with one fund. That is the type of approach that gives you the advantages of risk-adjusted returns, but also preserves capital. You must have a multi-strategy approach."
For "sophisticated investors," McCabe said she believes hedge fund investing belongs in "any diversified portfolio."
"Certainly in volatile markets, you have to have something in your portfolio that can make money when markets go up and when markets go down," she said. 
--by staff writer Shelly K. Schwartz
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