Red Kite fiasco sparks hedge funds debate

Recent days witnessed a big drop in shares of Indian metal companies after reports that a Denver-based hedge fund, Red Kite, which made huge exposures in copper and zinc, lost 30 per cent of its investments in a matter of days.

* A similar situation surfaced in domestic markets in September last year, when a Connecticut-based hedge fund, Amaranth, lost $6 billion in a week after its bets in natural gas went wrong.

Are our markets at the mercy of reckless global hedge funds?

"It seems speculators are trying to use the news to make quick profits by creating a panic-like situation in the market," said Chintan Modi, head of commodities at India Infoline.

The Red Kite impact saw a decline in international prices of zinc (18 per cent), copper (about 11 per cent) and aluminium (4-4.5 per cent). "In this kind of a scenario, investors are quick to square off their positions and might even go short, creating a negative impact on stock prices," he said.

Internationally, hedge funds operate in a very aggressive fashion that some funds go belly-up frequently. Vega Asset Management, with offices in London, Madrid and New York managing more than $12 billion, suffered heavily due to poor bets on global bonds in August and September last year. The New York-based MotherRock LP, a $400 million hedge fund, also shut shop last year, following wrong bets on energy prices.

These international developments have once again brought to the fore the debate on allowing hedge funds direct entry into domestic markets. Hedge funds can, currently, invest in domestic stocks using participatory notes (PN), issued by the Sebi-registered foreign institutional investors (FIIs).

"Hedge funds not only have shady background, but also speculative practices. They bring huge amount of money to the market, but, at the same time, they can perish at a short notice. Their direct entry will not help emerging markets such as India. In fact, this will raise volatility here," said former Sebi member L C Gupta.

A US-based economist, Marti Subrahmanyam, in a recent visit to Mumbai, had opined that India should permit direct entry to hedge funds, if it wanted its capital markets to be a part of global markets and see more foreign inflows.

"There is absolutely no need to stop hedge funds just because you don't know from where the money is coming to them. Essentially, the economy needs foreign capital and these funds can bring it in huge sizes," he had mentioned.But Gupta has a different take on the matter. "The government wants more foreign money to come into the market. But, that money should have a certain standing period. Hedge funds would not be investing in sectors such as infrastructure, where we need capital. They would always opt for quick-buck stocks."

India-centric hedge funds are seeking time-specific licences from the Sebi to operate in the country, whereby the regulator would be issuing one-year licences to the funds and would take decision over renewing their permission after watching their performance during the period.

Most of the developed markets have presence of hedge funds, which own capital of more than $1.5 trillion. Depending on performance, the funds give returns to the extent of 50 to 60 per cent.