Hedge Fund's double Bond Trading

In a report late last week by Greenwich Associates, 45% of annual trading in emerging market bonds, 47% of distressed debt and 55% of credit derivatives in the 12 months were reported to be hedge fund trading of bonds and derivatives in the US, more than doubling the tolal in the past year, giving the hedge funds so much influence that some markets can’t operate efficiently without them.

The report’s surveyed 1,281 investors, including 174 hedge funds. The investors surveyed accounted for $19.6 trillion in annual trading, according to the report.

Karan Sampson, a Greenwich consultant who cowrote the report said, “Because of the huge portion of the market that they represent, in some respects they (hedge funds) are becoming the market maker…..the broker is going to have to come up with faster and better products to retain the activity of the hedge fund,” Sampson said.

Hedge funds represented 15% of all trading in bonds and derivatives in the 12-month period, attracting $42.1 billion in investment in the second quarter, the most since 2003, and have returned 7% to investors this year through August, according to the Chicago based Hedge Fund Research.

Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates. Of course, speculators may trade with other speculators as well as with hedgers. In most financial derivatives markets, the value of speculative trading is far higher than the value of true hedge trading. As well as outright speculation, derivatives traders may also look for arbitrage opportunities between different derivatives on identical or closely related underlying securities.

Other uses of derivatives are to gain an economic exposure to an underlying security in situations where direct ownership of the underlying is too costly or is prohibited by legal or regulatory restrictions, or to create a synthetic short position.

The increasing influence of hedge funds is causing investors to worry that they are increasing risk, or creating more uncertainty, in financial markets, the report said.