Hedge fund bubble bursts in time for swine flu

Swine flu marks the bursting of yet another bubble. The latest airy hope to be deflated is over the world's ability to withstand the occasional pandemic risk. We did it with SARS in 2003 and avian influenza in 2005. That was before swine flu and the World Health Organisation's (WHO) declaration that it isn't containable. Forget surgical marks. Gas masks, anyone?

The question now is whether this disease will morph into an international disaster that will devastate markets.

Asia's future is also affected by the bursting of a second bubble: hedge funds. Almost 20 percent of Asia-Pacific hedge funds closed in the 15 months to March; with that rate set to accelerate in today's dire economic conditions, according to London-based magazine AsiaHedge.

If swine flu really is the ‘Big One', the effects of these two bubbles will converge, dragging down asset prices and deepening the recession.

Markets didn't need this challenge.

There's something almost biblical about what's happening around the world. Really, what's next? A plague of locusts? Raining frogs? The fragility of the global economy raises expectations for how public officials will handle swine flu. Any hint of incompetence will hurt markets early and often.

All this spells trouble for the world's most-populous region. This is also the most economically promising area, one on which corporate executives in New York, London and Johannesburg are depending for future growth and profits.

Asia, with its teeming populations, crowded cities, high poverty and spotty access to health care, must be considered a future hot zone. That's why even though Mexico is the epicentre, Asian governments are moving fast to prepare for outbreaks. The region's vulnerability will grow exponentially over time.

Even without swine flu, economies aren't close to bottoming. The best-case scenario is for growth to level off at very low levels. Stimulus packages of about $2 trillion globally aren't enough to offset the wealth destruction of the past 18 months. Mark Matthews, a strategist at Fox-Pitt Kelton in Hong Kong, puts the loss in equities alone at $30 trillion.

The credit crisis caused the shuttering of 129 Asia-region hedge funds in 2008. That's the most in at least eight years and more than double the number that closed in 2007. An additional 17 closed funds in the first quarter this year.

Hedge funds around the world are reeling after losing 19 percent on average last year. Investors withdrew $155bn, the worst performance since Chicago-based Hedge Fund Research Inc began keeping records. Investor redemptions have soared since Lehman Brothers Holdings Inc folded in September.

The health of Asia's hedge funds is less interesting than the forces that drove the industry's growth. At the end of 2008, there were around 930 Asia-region hedge funds, according to AsiaHedge editor Paul Storey. In 2000, there were about 160 Asia hedge funds. It was always a bubble that was waiting to explode.

At the time, investors said the sudden rush to start hedge funds in Hong Kong, Japan and Singapore reflected Asia's maturity. That was true to an extent. It was more about Asia's rapid growth and its underdeveloped markets.

The region was rife with the inefficiencies that speculators exploit. For anyone aiming to profit from disparities in the prices of similar bonds or other assets, Asia was an obvious place.

Then there was the bandwagon effect; there were suddenly too many aggressive investors pursuing similar strategies, thus cannibalising the benefits. And when markets were booming in the mid-2000s, lots of people who went to work at hedge funds had little hands-on experience. "If he can get rich, so can I" was the dynamic that pervaded the industry.

Some good may come of the current shakeout. Kirby Daley, a senior strategist at Newedge Group in Hong Kong, says the managers who survive will represent an industry that is stronger and more diverse in strategy. Still, it's impossible to say at this moment how many will be left.

Swine flu deepens the plot. It's a big concern that health officials are giving up on containment already. They are focused on treating patients and strengthening preparations for outbreaks. The WHO raised its global pandemic alert to the highest level since the warning system was adopted in 2005.

Asian markets plunged during the 2002-2003 outbreak of severe acute respiratory syndrome (SARS). SARS killed 770 people, a number that belies the hysteria that swept the region. In reality, SARS was the health equivalent of the Y2K computer bug in 1999. And yet it took a toll on Asia's economies and markets.

Swine flu concerns may also turn out to be overdone. If not, expect Asian markets to be in for an even rougher 2009 than seemed possible just a couple of weeks ago. And expect more hedge funds to go bust.

William Pesek is a Bloomberg News columnist. The opinions expressed are his own.