Greenspan fears investor backlash against hedge funds and CDOs

Federal Reserve chairman Alan Greenspan believes investors' pursuit of improving yields by investing in hedge funds and complex investment products – notably collateralised debt obligations (CDOs) – may spark a backlash when the results fail to perform as well as expected.

“Continuing efforts to seek above-average returns could create risks for which compensation is inadequate,” said Greenspan in an address via satellite to delegates attending the International Monetary Conference in Beijing on Monday. “Significant numbers of trading strategies are already destined to prove disappointing, a point that recent data on the distribution of hedge fund returns seems to be confirming,” Greenspan added.

He warned the hedge fund industry could shrink temporarily, and many wealthy fund managers and investors could become less wealthy, adding: “I trust such an episode would not induce us to lose sight of the very important contributions hedge funds and new financial products have made to financial stability by increasing market liquidity and spreading financial risk, and thereby enhancing economic flexibility and resilience.”

But Greenspan said he was not particularly concerned this may have a negative impact on financial stability as long as banks and other lenders are managing their credit risks effectively.