The rise of multimanager hedge funds poses a threat to financial stability, according to Bank of England Governor Andrew Bailey.
Bailey said there are signs of correlated activity, which combined with often ruthless risk management policies could see these funds rush to the exits during market shocks.
Multimanager funds, also known as multistrats or pod shops, have taken the lion’s share of investment flows in hedge funds in recent years, with clients attracted by the promise of steady and diversified returns from traders organized into distinct strategies, or pods.
“Multimanager funds can make individual ‘pods’ deleverage rapidly in stress conditions, which can exaggerate market moves,” he said in a speech at the University of Chicago Booth School of Business in London on Feb. 11. “There could be circumstances in which the means by which multi-manager funds protect themselves in this respect can create risks to the system.”
Responding to questions after the speech, Bailey said the scale of growth in non-bank finance, which includes hedge funds, “is putting some pressure on what we perceive of the limits of prime brokerage capacity.” This refers to the investment banking teams that handle trades for large clients such as hedge funds, which the BOE has been reviewing following the collapse of Archegos. Bailey said this area has become more concentrated.
He said the multimanager hedge fund model does offer benefits, in that pods operate under a “sophisticated umbrella risk management which can lean against large fund-level concentrations.” However, “correlation can still emerge across different funds as different multimanagers are often attracted to similar types of strategies,” he said.
The BOE and other regulators globally are paying more attention to the rapid growth in finance activity outside banks. The central bank’s System Wide Exploratory Scenario in November found hedge funds, asset managers and pension providers could be “underprepared” in times of crisis. The BOE also launched its first repo tool to lend directly to certain buyside firms in times of market stress, such as the gilt crisis in 2022.
Bailey also pushed back against the U.K. government’s deregulation agenda, saying there is no trade-off between growth and financial stability.
