Those based in offshore domiciles like Bermuda are coming under increased scrutiny, Laura Wetherell reports.

Hedge funds have been blamed for wild volatility across global stock, bond and currency markets and attracted calls for tighter regulation.

The majority of the funds are said to be based either in the US, where they originated, or offshore, where they fall outside the direct control of banking and securities regulators.

The Bermuda Monetary Authority records about 375 mutual funds in Bermuda, which includes the highly leveraged hedge funds, with $7.8 billion assets.

Most fund managers do not have a presence here, but buy accounting and evaluation services from Bermuda's banks.

Mr. Raymond E. Dill, manager of corporate trust at the Bank of Bermuda, said that four of the world's top 10 hedge funds are always Bermuda-based.

The Bank of Bermuda services more than 300 mutual funds, including some of the biggest hedge funds -- although reluctant to publicly name names, the funds are among the most prestigious.

The bank also claims to have a grip on 80 percent of the total mutual funds market in Bermuda.

"We are the best,'' said Mr. Luis A. Douglas, the Bank of Bermuda's general manager, corporate trust. "Mutual fund administration is one of core businesses of the bank. We have been at it for a long time. As a multi-jurisdictional bank, we can service these funds internationally.'' The term "hedge fund'' has lost its original meaning which suggested that funds are protected against adverse market movements.

Mr. Mohamed Zayan, managing director and partner at Strategic Asset Management (SAM) said the term hedge fund is now a misnomer.

SAM manages Strategic Asset Management Global Fund an average sized hedge fund of $300 million from Bermuda.

"They should be called leveraged funds. Hedged means some form of protection, but it doesn't describe what we do,'' said Mr. Zayan.

Leveraged means using borrowed money. "We take the money we have under management, and leverage that money by borrowing against securities from investment banks and commercial banks to gain more leverage, so we can play with bigger sums of securities,'' he said.

Mr. Douglas said almost every mutual fund hedges in some respect. "If you sell short, you are hedging. If you enter into a futures contract to hedge your currency positions, you are hedging.'' Selling short is defined as selling securities that a fund does not own.

"Hedging is prudent. If an investment manager is going to protect his shareholders, then he will hedge his bets. In addition to taking a particular strategy, he will say: " `Let's do something where the results are less dependent on strategy one' -- to minimise risk.'' "What are referred to as "the big hedge funds'' are the ones that deal in very complex instruments,'' said Mr. Douglas.

As hedge funds became popular in the US, hedge-fund managers set up offshore funds.

The Bank of Bermuda said it does not lend to the big funds, because they are so huge.

"Their borrowing requirement exceeds our capacity to lend. We lend to mutual funds, based on 15-20 percent of the value of the fund. We are conservative, and it is excellent business. We are the custodians. We have the security in our hands,'' said Mr. Douglas.

Mr. Malcolm Williams, BMA general manager, views the business from a different perspective.

"Not long ago it was unthinkable that an individual, or companies, which an individual owns, could borrow $1 billion from a bank to invest in either mutual funds or the currency markets,'' he said.

"Today, that is possible because of the growth of the banks' expertise around the world, so it is not unexpected that some large banks are able to lend large sums of money, which may be used to hedge against specific source of risk,'' he said.

Risky betting turned against the market players earlier this year.

Hedge funds made huge losses -- a maximum of about 20 percent during January and February, said Mr. Douglas -- but he stresses losses must be put in context.

"Hedge funds have never taken a bath like this one before, but these same hedge funds made 30 to 50 percent the year before.'' "The big hedge funds, which took severe losses, have very experienced, conservative and solid fund managers. They have long track records.'' "They have lost money in a short period of time, but will again make money in a short period of time.'' The panic attacks in the financial markets were first triggered by American bond markets plummeting. In response, Japan's bond markets also fell sharply on March 2 this year. European bond markets were then rattled by the two heavy falls in New York and Tokyo, followed up by news that the Bundesbank was unlikely to ease interest rates.

Investors were described as seizing on any news -- even good news -- as an excuse to sell bonds.

Market players pointed an accusing finger at hedge funds for exacerbating the slide.

SAM global fund was one that did lose out recently.

The fund made four percent in January, and then lost 11.

87 percent in February, said Mr. Zayan. The fund is up three percent in March, so, all in all, it will have lost four percent in the first quarter, he said.

"For at least the last two years, the fixed income markets enjoyed a massive rally,'' said Mr. Zayan. "It was long and uninterrupted, and hedge funds made much money.'' The recent losses have brought fund managers down to earth in his view.

"They were making money hand over fist, month after month. It was the first month that people got losses of that magnitude.'' But compare the losses to the gains and they are "nothing'', he said.

"The fund made 160 percent returns last year, so to lose 11 percent in one month is nothing.

"We can invest in securities that are multiple the size of the fund. We leverage our funds an average of ten times, but some leverage more than that.

It all depends on risk appetite.'' It is this risk appetite that concerns many regulators. The Monetary Authority outlined the concern that banks around the world are taking big risks by lending huge sums to hedge funds. The regulators are worried that many mutual funds are being marketed by the banks.

Mr. Jamsheed A. Khan, a BMA manager, said: "There is one twist to bank lending that is frightening.

"When a bank takes a deposit of $10 million, the fund or individual who deposits that sum may have an agreement which permits investment, or gearing, of ten times that amount.

"It is that additional risk that banks typically have not been able to put a handle on,'' he said.

Mr. Zayan is in favour of regulators taking a closer look at the industry.

"I don't want one or two crazy hedge funds, who use massive leverage and do not know what they are doing, going belly up and causing problems for the industry in general.'' Mr. Williams said there is "universal concern'' about the growth of the mutual funds industry, and their effect on the world's bond, securities and currency markets.

"Bermuda is certainly part of the world market in terms of banking and mutual funds. It can not escape from the standards of supervision, which are expected internationally,'' he said.

"Bermuda is looking at its mutual funds sector to see whether legislation, regulations, or a code of conduct might be needed in the near future. We are aware of increasing action to introduce more solid forms of investor protection. It is only inevitable that some additional form of protection will come about.

"We must be careful that we are not seen to be outside the international arena of supervision,'' said Mr. Williams.

Over the last year and a half, a Bermuda International Business Association sub-committee has worked on a code of conduct.

Mr. Douglas, who is a member of the mutual fund sub-committee, said: "Do not expect much change. The new code of conduct continues to bless our posture regarding mutual funds in Bermuda, which is to have them as self-regulated as possible.'' "The last thing that sells is regulation. The type of regulation that exists in the UK and the US is counterproductive to doing business.

"Hedge funds are big,'' said Mr. Douglas. "They move big blocks of securities. The regulators do not like it, because it is outside their control. It is driving them mad. Now, they will try to find out how they can inject themselves into the whole thing.'' "There is no adverse reaction to regulation as long as it is prudent and intelligent regulation, and doesn't add to the clerical burden. We all want to present a front that emphasises the integrity of Bermuda as a jurisdiction.

"Bermuda has many competitors. There is no reason why a fund manager has to come to Bermuda. He can go to Cayman.

"If Bermuda starts trying to adopt the kind of regulations that are typical of an onshore institutions, Cayman will laugh all the way to the bank.'' REGULATORS like Bermuda Monetary Authority general manager Mr. Malcolm Williams, above, and BMA officer Mr. Jamsheed Khan, below, warn more mutual fund regulations may be necessary.