Friday, April 14, 2006

Wall Street, Hedge Funds, and REinsurance.

The proliferation of hedge fund-backed reinsurance concerns has interesting ramifications. Hedge funds are becoming increasingly “institutionalized” with myriad regulations and “transparency” requirements. (as if the private investors who capitalize hedge funds require this type of protection)

The idea is that reinsurance negatively correlates with fund returns. Now, while I have railed extensively about the impossibility of long-term asset corellation due to the constant of “ever changing cycles” within and among asset classes, the entrance of hedge funds into the reinsurance industry seems to marry the compentancies required of both types of businesses. Both rely heavily on statistical modeling (most hedge funds have personel who are quantitatively astute), retrospective and prospective anlysis regarding a complex object, and good fortune to turn a profit. In addition, there is little danger of the all-too common “front-running” that hedge funds must endure in the securities markets by way of their primary broker…

Here is how this works: A hedge fund will devote considerable resources analyzing the capital markets in preparation of taking a market position by buying or selling securities. The hedge fund places an order with their prime broker, which proceeds to walk straight over to their own “proprietary desk” and inform them of the hedge fund’s position. The prime broker then freerides off the hedge fund’s market intelligence, often times taking its own position prior to filling the order of its client. This occurs (very) frequently. Not only are the positions of the hedge funds compromised, but the funds must pay exhorbitant fees to borrow securities from their “prime brokers”.

Which is why neither this:

http://tinyurl.com/gdvs4

Nor this:

http://tinyurl.com/hq3a4

Comes as a surprise.

Hedge funds are now searching for more advantageous pools to tread…private equity and reinsurance being the most tepid and familiar waters...and without so many circling sharks.

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