The ECB narrative on hedge funds
"Here is the 'overall assessment' from that section. It's quite a stark warning, accompanied by some compelling analysis:"
(Below quote is from the ECB (2.5 mb PDF!); the excerpt marked with bold is important in my opinion!)
"As the hedge fund industry keeps on growing, its expansion continues to raise questions about capacity constraints and the impact of hedgefunds’ largely unconstrained investment strategies on financial markets. In addition to potentially high leverage, the increasingly similar positioning of individual hedge funds within broad hedge fund investment strategies
is another major risk for financial stability which warrants close monitoring despite the essential lack of any possible remedies. This risk is further magnified by evidence that broad hedge fund investment strategies have also become increasingly correlated, thereby further increasing the potential adverse effects of disorderly exits from crowded trades.
It is difficult to gauge what could cause correlated sell-offs and how damaging these could be, but one possible trigger could be an abrupt end of the recent global search for yield possibly induced by the tightening of global
liquidity conditions. A further slowdown of inflows into hedge funds or even widespread redemptions could also exert pressures on individual hedge funds to liquidate increasingly less liquid holdings, as more hedge funds seemto be venturing into less liquid markets in order to earn the associated liquidity premium. Since the valuation of such investments is often arbitrary, investors may not always be presented with an accurate picture of fund positions and