Listen to Influential investment strategist Byron Wien talks about the S&P500 hitting a technical low, when it hit 666 - “the devil’s number” - earlier this year.

The financial industry has been turned on its head, and that includes hedge funds. Hedge funds now face questions about structure and regulation as scandal casts a long shadow over the industry.

Investors like Adrian Biondo say they don’t know when they can trust again. Diane King reports from New York. Speakers: AJ Mediratta, Senior Managing Director, Greylock Capital Management; Adriane Biondo, Madoff Former Investor

Diane King, Reuters, New York

SOUNDBITES:

The once-booming $1.4 trillion hedge fund industry faces its toughest challenge ever, in the form of record poor performance last year and heavy client outflows. 
 
And the $2.5 trillion private equity industry is licking its wounds after a year in which it made headlines more for bankrupt portfolio companies and collapsed deals than for the kind of mega-takeovers it was famous for just two years ago. Adding insult to injury, many investors are looking for ways to dump their once-coveted investments in private equity firms as they look to shed risk and the industry’s tax treatment is in the sights of the Obama administration.
 
There are deep-seated concerns over the health of the industry and the leveraged buyout model itself. With high levels of debt now pushing many private equity-owned companies into breach of their banking covenants, how many portfolio companies will fail and how many of their private equity backers will vanish?

 
Speakers at the Reuters Private Equity and Hedge Funds Summit taking place in New York, London and Hong Kong will address these questions, and discuss who will be the winners and losers out of the crisis, how much worse conditions will get and how much further the industry could shrink. Regulation, a widely-debated topic in both the U.S. and Europe, will also be a key discussion point.
The Summit will generate exclusive interviews and articles, as well as regular blog postings and online video.

“Well insulated” China, though suffering from sharp drops in its own equities markets, doesn’t have the sense of crisis that exists in the U.S., says Philip Partnow, managing director of UBS Securities Ltd in Beijing. UBS, the first Western bank to assume management control of a domestic mainland brokerage, points out the fact that what’s hitting companies is not subprime-related securities gone bad.

“I think there’s nothing here we feel is toxid,” he told Reuters on Wednesday at the Reuters China Summit in Beijing. He goes on:

“The Chinese capital market has responded quite differently than global capital markets and that is because the Chinese capital markets are still pretty well insulated by the way China controls the RMB and by the other financial controls that China has.

“It is true that both the Shanghai A-share market and the Heng Seng market have fallen quite steeply, but that is more in response to a correction from what many people believe was an over-inflated stock bubble, rather than a direct response from some financial crisis or concern. That’s been then followed on by some concerns that people have about a weakening economic sentiment in the U.S. and Europe and Japan, which are China’s key export markets, and what the knock-in impact will be in China. So there is also a fundamental concern.”

“But there is not a sense of distress or of crisis, or that things that people thought were valuable suddenly vanishing into thin air, along the same lines of what we’ve seen with some of the things that were happening with Subprime and the complex structures that were set up around the subprime, back in the United States. So I think there’s nothing really that we feel that is toxic, out here in China, so we are broadly comfortable with the businesses that we’re in. “

By Lucy Hornby

Marathon Asset Management, an $11 billion hedge fund and private equity group, is snapping up banks’ assets “across the spectrum” at a big discount, from residential mortgages to commercial real estate loans to leveraged loans, Chief Executive Bruce Richards tells the Reuters Hedge Funds and Private Equity Summit.

Richards seems to have a keen sense of how badly the banks want to unload such distressed assets, giving him a strong negotiating position to push for the lowest possible price.

“They’re sitting behind closed doors and figuring out right now with regulators and with their own internal risk committees and treasury departments how they fund themselves in today’s market environment and how they get risk down,” he says.

Going forward — and given the generous funding terms the Federal Reserve is now offering them – banks actually have a great opportunity to make money on new loans, he says.

But to do that, it’s crucial that they free up space on their balance sheets. That’s why Citigroup’s agreement to sell $12 billion in loans is likely to be just one of many such deals by a variety of banks.

“Right now, they have to get through the problem assets that are on their balance sheet to get that more manageable and get their leverage down,” Richards says. 

Amazon.com’s Kindle “wireless reading device” is an example of both the threat and opportunity that new media platforms pose for the newspaper industry, according to Quadrangle Group’s Josh Steiner.

Steiner owns one of the hard-to-find devices, which have been consistently sold-out on Amazon . He said its wireless features are particularly promising — you don’t have to plug into a PC or look for a WiFi hotspot. It’s also searchable and allows you to customize the type of news you want to read.

“That’s the threat and the opportunity because it’s not just the question now of (newspaper) content being divided and repackaged,” he told the Reuters Global Hedge Fund and Private Equity Summit. Quadrangle, the private equity firm founded by former reporter Steve Rattner, is an advisor to the New York Times Co.

He admitted that the Kindle is very far from a complete package, but said it’s still worth a close look “if you want a sense of where I think the world is going…where technological evolution has the ability to disrupt existing business models and in some cases enhance them.”

The hedge fund industry has moved away from its roots and lost its “crazy” spirit, says Eclectica Asset Management’s chief investment officer Hugh Hendry.

Whereas hedge funds used to be freewheeling vehicles able to exploit excellent opportunities with small pots of assets, many have now become large institutions or are far too correlated to equity markets, he says.

He believes the returns in the hedge fund industry will fall and could even be negative this year.

Richard Baker, who recently resigned his House seat to become president and CEO of the hedge fund industry’s main lobbying group, the Managed Funds Association, says he’ll be making a big push for fund companies to bolster the election year campaign kitties of influential legislators.

“I am going to be aggressive in asking our members to make contributions,” the former Louisiana congressman says, claiming that the MFA actually punches below its economic weight compared with other big lobby groups.

A major effort by the Treasury to overhaul financial regulations make it all the more crucial for the industry to try to wield influence in the way that tends to get the most traction in Washington, he says.

Baker says it would practically be a dereliction of hedge funds’ duty not to write big checks to their congressmen “given the political environment which we’re in going into a competitive election cycle.”

Markets are still anxious following the financial implosion of Bear Stearns but the situation has vastly improved since the Fed stepped in, Pacific Alternative Asset Management CEO Jane Buchan told the Reuters Hedge Fund and Private Equity Summit on Tuesday.

“Two weeks ago, it was clear people were trying to take Lehman down,” she said, which was one of the main reasons the Fed got heavily involved in arranging for JPMorgan to buy Bear Stearns, and lending directly to Lehman Brothers and other Wall Street brokerages.
“Everyone was talking about Bear Stearns, but I think the bigger issue is, who was next,” said Buchan, whose company runs a $10 billion hedge fund of funds. But the Fed’s moves at the time “really calmed the market.”

“I think the market’s come to the conclusion that the Fed’s going to backstop this and no one else is going down,” she concluded.

PequotVentures, the venture capital arm of hedge fund Pequot Capital Management, has shut down its Silicon Valley office and now operates only out of New York. Managing general partner Lawrence Lenihan said the contrarian move made sense because the plethora of venture capital operators in Silicon Valley forced PequotVentures to compete on price.

That’s not so true in New York, where there’s less competition on the fund side but lots of promising media and finance businesses, he told the Reuters Hedge Fund and Private Equity Summit on Tuesday.

New York is also looking like increasingly fertile ground relative to Boston’s once booming Route 128 corridor. Lenihan, who admits that as a New Yorker he may carry a certain bias, said that shuttle flights which once were packed with New York investors going to Boston to check out companies are now carrying many more Boston investors in the opposite direction.

“If you look at the deal flow and you look at the amount of companies that are being built, I think there’s been a noticeable slowdown in technology innovation in the Route 128 corridor,” he said.