The rapid rise of multi-manager hedge funds could pose significant risks to financial stability due to correlated activity and their aggressive risk management practices, according to a report by Bloomberg citing comments from Bank of England (BoE) Governor Andrew Bailey.
The report cites Bailey as saying at the University of Chicago Booth School of Business in London on Tuesday, that combined, these factors could exacerbate market instability during times of stress.
While multi-manager hedge funds, also known as multi-strats or pod shops, have attracted the majority of hedge fund investment flows in recent times by promising steady, diversified returns Bailey cautioned that their structure, with traders organised into distinct strategies or pods, could amplify market disruptions.
“Multi-manager funds can make individual ‘pods’ deleverage rapidly in stress conditions, which can exaggerate market moves,” Bailey said. “There could be circumstances in which the means by which multi-manager funds protect themselves in this respect can create risks to the system.”
Responding to questions after his speech, Bailey also pointed to challenges stemming from the growth of non-bank financial institutions, including hedge funds. He noted that the scale of expansion in this sector is straining the capacity of prime brokerage. This area has grown increasingly concentrated, raising further concerns in the wake of events like the Archegos collapse.
While the multi-manager model provides benefits through its “sophisticated umbrella risk management” that mitigates fund-level concentration risks, Bailey warned that similar strategies pursued by different multi-manager funds could lead to systemic correlation.
Bailey’s remarks though have drawn criticism from the Managed Funds Association (MFA), which represents the alternative asset management industry, including hedge funds.
In a statement, Jillien Flores, the MFA’s Head of Global Government Affairs, said: “The structure of hedge funds enhances financial stability, as hedge funds have no government backstop, no liquidity mismatch, and losses are siloed to an individual fund and its sophisticated investors. Regulators have visibility into the activity of hedge funds through existing regulatory reporting and the funds’ broker-dealer counterparties. Through these channels regulators can monitor for risks to the financial system.”
