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19 Sep 2006

Hedge Funds and US Elections

Hedge funds are proving to be a growing power in the political arena, complicating the issues by pouring funding into the Democratic side of the playing field, giving mostly to candidates and causes that interest them personally, rather than targeting key lawmakers with influence over regulating the industry.

Hedge funds priorities seldom align with those of others in a sector already full of conflict. The rise of hedge fund managers as a political force is expanding the financial sector’s Washington presence.

“The hedge funds have tremendous political clout but they also have significant enemies. The mutual funds hate the hedge funds … The corporate community sees them as destabilizing,” said Columbia University Law School Professor John Coffee in an interview with Reuters.

Campaign finance records show 20 of the most successful U.S. hedge fund managers have pumped more than $3.1 million into campaigns so far in 2005-2006, up from about $1.1 million by the same group in the last mid-term election cycle.

Donors such as George Soros, of Soros Fund Management, has given more than $2.3 million, according to PoliticalMoneyLine, a campaign finance research group. D.E. Shaw & Co. has given $78,600 so far and the Gaine group has donated $122,500 in this cycle.

James Chanos, president of hedge fund Kynikos Associates, set up a group called the Coalition of Private Investment Companies to urge hedge fund managers to be more politically active. Hillary Clinton is also a frequent recipient of hedge fund donations.

Hedge fund giving is still not as strategically targeted as donations made by bankers, insurers and other, older financial interests, which are generally more pro-Republican.

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.