Is this really the Hedge Funds' World?

Probably every Gulf financial institution and high net worth individual has some exposure to hedge funds, whether directly or indirectly through their intermediaries.

In recent years poor stock market performance has resulted in more and more money being placed with the mathematicians and rocket scientists who run these funds. Crucially most investors have not a clue what they are investing in, and there are few genuinely independent analysts.

Indeed, hedge fund managers are among the planet's highest paid individuals, so rare is their talent. But they have proved their worth. And in the past few years they have acquired the most blue-chip of clients, namely the world's largest banks.

In the Economist magazine this week a risk-management consultancy RiskMetrics is bold enough to speak out. It says the present situation is not dissimilar to the one that preceded the collapse of the Long-Term Capital Management hedge fund in autumn of 1998.

The problem, according to RiskMetrics, is that the banks' financial modeling assumes flat movements in financial markets, and does not allow for a sudden downturn. Thus the impact of another financial crisis would be greatly multiplied by the banks' exposure to hedge funds.

So far the banks have only seen the upside of hedge funds, vis-à-vis great financial performance in dismal financial markets which has helped keep bank profits extraordinarily high during this difficult time.

It is to be hoped that the rocket scientists and mathematicians have got it right. But a situation where many on Wall Street view Goldman Sachs as more of a hedge fund than a bank looks pretty serious.

Hedge fund performance faltered in many cases in 2003, after five stellar years. Now the industry needs to prove that what goes up will not necessarily come down.