Hedge funds overleverage and 'anyone can go down,' Sprott warns

By Emily Mathieu
National Post, Toronto
Friday, November 24, 2006

http://www.canada.com/nationalpost/financialpost/story.html?id=28752457-...

Overleveraged and unchecked investments in the hedge fund industry are keeping investment guru Eric Sprott up at night.

"My biggest fear, as a hedge fund manager is 'Where is the cash?,'" Mr. Sprott, chief executive and portfolio manager of Sprott Asset Management Inc., said yesterday. "My gut reaction is that we need regulation" of the industry, he said.

Investor interest, combined with incentives for managers, means the hedge fund market is booming, he told a symposium of hedge fund managers, investors, and analysts in Toronto.

But the cash is not always in the right hands, said Mr. Sprott, whose fund has $472 million of assets under management.

"If you are too leveraged, anyone can go down," he said. "There is tremendous leveraging going on in hedge funds and the bank system."

Between Dec. 31 and June 30 there was a 24 percent increase in the dollar value of the derivative market, he said.

As one example Mr. Sprott pointed to the number of outstanding credit default swaps (CDS) that have "gone absolutely bonkers" over the past few years.

Rapid growth in the CDS market isn't alarming on its own -- it's how they are being used, said Mark Purdy, managing director and chief investment officer for Arrow Hedge Partners International Inc., a Toronto based hedge fund with $700 million in assets under management.

"Properly employed, the tools can be quite useful, but the instruments are relatively new and it would be fair to say they have not been tested through different market cycles," he said.

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