Maximiliano Durazo (University of Southern California, USA)
Professor Kazuhito Ikeo's article, "Integrity is Indispensable for Capital Market Development" emphasizes the value of integrity in Japan's capital market. In the absence of integrity, investors in a capital market spend excessive time and effort in assessing lies, strategic intent, and concealed information. Of significant concern to the modern capital market is the hedge fund. It is estimated to be a $500 billion industry and grows at about 20% per year. Currently there is little regulation, and it is impossible to precisely determine the extent of market share that hedge funds are responsible for. As hedge funds increase in popularity, the issue of regulation becomes more of a concern.
I favor Professor Ikeo's opinion on integrity and believe the issue of integrity should be applied to the hedge fund. Hedge funds can have a significant impact on Japan's market as well as the global market. In only seven days, Eifuku Master Trust (a Japan based hedge fund) lost nearly all of its capital. In December of 2001, Eifuku Master Trust had reached $300 million in assets. By April 9, 2003 that number dwindled down to $5 million in capital. Prior to this demise, the hedge fund manager used extreme levels of borrowing to generate the largest trading commissions in Japan. The fund had reported 70% profit the prior year and was reportedly somewhere around 10:1 leveraged.
One of the distinctions of the hedge fund is its ability to use leverage to enter and exit positions quickly. In some cases, it results in a gamble with concentrated positions, and since the regulation is lax, it is difficult to ascertain the trading strategies employed by the fund. Due to lack of regulation, investors of the Eifuku Master Trust were unaware of the extremely concentrated portfolio or leverage. Integrity should have motivated the fund manager to reevaluate his investment strategy.
According to Quinn Mills, from the Harvard Business School, the growing popularity of these funds has increased speculation in the equity markets and has caused them to perform similar to currency markets rather than investment markets. Mills argues for regulation to force these funds to disclose accurate performance data. Although the law does not require in-depth disclosure, integrity should motivate hedge fund managers to accurately convey the performance of the funds to the investors. The lawsuit against Towry Law illustrates this point. In Japan and other countries, Towry Law reportedly sold high-risk investments as low-risk. These high-risk hedge funds eventually lost up to $400 million.
Hedge funds are presumed to be the next big bubble. Mills explains that the same mutual fund managers who performed poorly and lost during the technology bubble are now hedge fund managers. Investors, who do not want these hedge fund managers to handle their money, invest with banks, assuming their investments are less risky. Unbeknownst to the investors, large banking institutions are using the money to invest into hedge funds run by some of the technology bubble mutual fund managers. The common term for this is "funds of funds." Due to lack of regulation, the source of gains or losses of the fund becomes obscure or completely unknown.
According to Teneo Partners, in Japan, an authorized foreign broker is allowed to sell to institutional investors as long as the sale is made from overseas and soliciting has not occurred in Japan. In actuality, intermediary marketers aggressively pursue investors and then declare that the consequent orders were received unsolicited. Not only is this illegal but also clearly lacks integrity.
Hedge funds can be an asset by increasing the efficiency of the market and assisting with market liquidity. Although there have been scandals, it is argued that they do not represent the entire hedge fund market. Opponents of regulation assert that it interferes with the operation of financial markets. Supporters of additional regulation argue that there should be limits on currency speculation, more protection against fraud, and required disclosure. A sincere assessment of the risks and rewards of hedge fund regulation for individual and global markets is prudent. In the absence of strict regulation, integrity should motivate hedge fund managers to operate beyond the rule of law.
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