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Morgan Stanley Investment Chief: Hedge Funds Have Become Volatility-Shy

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NEW YORK (–After years of being considered synonymous with excessive risk, hedge funds are now avoiding it and becoming more like mutual funds, a hedge fund veteran said Wednesday.

According to Morgan Stanley Managing Director and Senior Investment Strategist Byron Wien, there has been a philosophical shift in the industry toward reducing volatility and making do with lower returns.

“This is the most serious problem facing the industry,” said Mr. Wien, speaking at a symposium organized by Ernst & Young. He referred to a new essay he has written in praise of high volatility.

Mutual funds took 50 years to go from a performance-oriented structure to an asset-gathering structure, whereas it has taken hedge funds only five years to make that unfortunate transition, he said.

From this point of view, managers that rely on management fees do not want to risk a loss because that may cause investors to withdraw assets. And most managers have their own money in their fund and do not want to take a personal risk.

Mr. Wien argued that hedge fund managers should take risks in keeping with their skills so as to generate high returns. Investors can protect against the volatility that goes with these returns by managing a portfolio of hedge funds, he pointed out.

He also suggested that there could finally be downward pressure on hedge fund fees. With mediocre returns, whether from market conditions or from deliberate avoidance of risk, fees will loom as a larger issue for investors.

Mr. Wien is a seasoned hedge fund investor, both on his own account and as a member of various institutions’ investment committees. However, his track record with predictions has not been stellar this year.

In January 2004 he gave better than even odds that over the year the U.S. equity market would continue its strong performance from 2003, the Federal Reserve would not raise short-term interest rates and Marsh & McLennan would show “exceptional performance”–this last forecast presumably in a positive sense.