Over the past half-decade the performance of the euro zone, US and UK economies – in terms of both output and employment – has been the worst since the 1930s. This medium term performance has accentuated a trend in the developed world (including Japan) towards a slowing of economic growth over a full half century.
This growth deceleration has happened despite an accelerating pace of innovation, including in financial services, which theory suggests should boost growth by raising productivity levels. Weak economic growth has multiple implications. One implication is for investor returns, which are ultimately linked to underlying economic performance.
All the major crises in the developed world – from Japan in the early 1990s to the most recent crises in Europe and the US – have been caused primarily by the large-scale misallocation of capital. This has happened despite the financial services industry growing significantly in size relative to overall output in most countries and becoming more complex and sophisticated.
At this juncture, cost/benefit analyses of large, liberalised financial sectors appear to point to higher costs than previously believed (in terms of crashes, lost output, sharp increases in public indebtedness, etc) and lower benefits to the real economy. This may lead to a more fundamental policy shift towards the financial services industry, with greater regulation not just as a response to the 2007-08 financial crisis, but as a longer term response.
If that does happen, the hedge fund industry is unlikely to be unaffected. Combined with the on-going maturing of the sector (a development delayed in the mid-2000s by the general financial mania), more aggressive regulation would all but guarantee the sort of significant change that promises to make the considerably more conventional and less alternative in the years ahead.
Dan O’Brien is Chief Economist of the Institute of International and European Affairs, one of Ireland’s leading think tanks. He is also Adjunct Senior Research Fellow at the School of Politics and International Relations at University College Dublin and a columnist and economics analyst for the Independent Newspaper group.
He was a guest speaker at the EY FS Hedge Fund Symposium that took place in the Shelbourne Hotel on 21 November 2013.