Page last updated at 15:20 GMT, Tuesday, 28 October 2008

Hedge funds 'facing credit storm'

Pound notes
The Bank says hedge funds have just had one of their worst ever quarters

The Bank of England has warned that the hedge fund industry could be the next big victim of the credit crunch.

Hedge funds might be being forced to sell off their assets as they are finding it harder to attract the funds they need to invest, the Bank said.

It said that a growing number of the hedge funds' existing investors were pulling out their cash.

Hedge funds are a specific type of private investment fund that typically attracts wealthy private investors.

They aim to make a profit from the investments by using a range of sophisticated investment strategies.

'Worst quarter'

The Bank's latest Financial Stability Report said hedge funds had just had "one of their worst quarters on record", and were having to sell off their assets.

Some hedge funds will continue to be very successful, but there is going to be less hedge funds, we have already started on that process
Bob McKee, Independent Strategy

Bob McKee, chief economist at research group Independent Strategy, said a growing number of hedge funds were already having to close down.

"We are either seeing hedge funds closing down, or investors are starting to redeem their investments," said Mr McKee.

"In addition, the returns on their investments are now really appalling - some aren't making any money for their clients.

"As a result, some hedge funds are now in considerable difficulty, particularly those who have leveraged [effectively borrowed] greatly.

"Some hedge funds will continue to be very successful, but there is going to be less hedge funds, we have already started on that process."

A typical hedge fund investment involves borrowing shares from long-term investors, such as pension funds, for a "rental" fee, and then selling them.

The hedge fund then buys back the same number of shares and returns them to the lender on an agreed date.

If the price has fallen, the difference between the price at which the hedge funds sold the shares and bought them back is profit - so hedge funds are therefore able to make money from falling share prices.

Insurance firms

The Bank of England report also cautioned that some UK insurance companies were now seeing capital losses caused by the fall in value of their investments in shares and corporate bonds.

However, the Bank tempered that "insurance companies seem relatively well placed to avoid liquidity difficulties" because they held such investments for the long-term rather than any short-term profit-taking.

Insurance group Aviva, which owns Norwich Union, on Tuesday reported a 12% rise in nine-month sales.

It also said its capital position remained "strong", with a surplus of 1.3bn on 24 October.

However, this was down from 1.9bn on 30 September, partly because of the 22% fall in UK stock markets between the two dates.

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