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Hedge fund managers might want to begin to learn some Czech as the Eastern European nation becomes one of the latest countries attempting to kickstart a domestic financial industry. The opportunity to establish Prague as a financial center comes as a change in European Union regulation, coming into effect in July, gives preferential treatment to funds located within the borders of the Eurozone. While many of the thousands of hedge funds that will be seeking a local presence will look at the traditional hedge fund hubs such as Luxembourg, many other cities and countries are seeking the opportunity to host firms and the high paying jobs that they bring.

Perhaps surprisingly, the Czech Republic is well positioned as an attractive option for hedge funds, with relatively low local costs of office space and labor, close connections via air to major European centers and a relatively strong financial system. The country’s credit ratings are sound and, in fact, Czech government bonds are trading at a premium to higher rated French securities. That said, political risk remains elevated compared to other European nations, with one of the leading Socialist parties outwardly expressing a less than enthusiastic attitude towards business.

Capacity Issues Leave Luxembourg Stretched

The flood of hedge funds seeking European offices is beginning to have an impact on traditional centers such as Luxembourg. As prime office space and staff become scarcer, firms are finding it more difficult to establish a presence at an affordable price. This is where countries such as the Czech Republic come into play, offering firms the ability to establish a presence within the boundaries of the European Union, but at a very affordable price.

“There may be an issue of capacity backlog in Luxembourg and Ireland if tens of thousands of funds want to domicile,” Czech Deputy Finance Minister Radek Urban told Bloomberg, indicating his plans to draft legislation favorable to firms that wish to locate within his country.

This capacity issue has only been increased by financial turmoil in Cyprus, which has effectively eliminated one potential financial center from the list of hedge funds seeking European offices. While this reduced supply works in favor of countries such as the Czech Republic, it may also increase the important of financial and political stability in the finds of prospective companies.

The Czech Republic Not Only European Country Vying for Hedge Fund Offices

The Czechs are not alone in seeking out the tax revenues and highly skilled jobs that hedge fund offices bring to their economies. More traditional financial hubs such as Frankfurt and London are also expressing interest in making themselves more attractive to potential re-locators. While these jurisdictions certainly carry higher costs than Eastern European locales, they do offer more perceived stability politically and closer physical connections with important markets. While this additional stability will likely drive most of the hedge funds seeking European offices to setup in Western Europe, certainly many will be tempted by lower costs and consider the Czech option.

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After a strong finish to 2012 that saw many hedge fund managers enjoy the largest profits in several years, many in the industry are now becoming hopeful that 2013 will bring the same level of success. The Financial Times is reporting that the first quarter of this year will likely be one of the strongest ever for many hedge funds, as they ignore global economic concerns and pile into riskier assets.

In what may be a surprise to many, European-focused equity funds have been some of the strongest performers to date. For example, the largest European equity fund manager, Landsowne Partners, saw its flagship fund climb 7.75 percent in the first two months of 2013. Whether European funds can maintain their edge amidst gathering economic storm clouds remains to be seen, though many funds have built a significant buffer of positive returns already this year. Other top performing European managers, according to the Financial Times’ report, included Sloane Robinson, with a 17 percent year to date return, and Egerton, who enjoyed an 8 percent climb in the first two months of the year.

These returns also compare well to global equity benchmarks, which is a positive development for an asset class that has struggled to outperform equity indices for some time. While an 8.5 percent rise in the S&P 500 is certainly strong overall performance, top performers in the hedge fund industry are now providing even stronger returns to their investors. Over the past five years, the average hedge fund has only returned 8 percent to investors, so to see that kind of performance in a matter of two months is encouraging.

Are Returns Symptomatic of Excessive Risk Taking?

One concern for investors will be whether the increase in returns is simply reflective of hedge funds taking on risk in a desperate attempt to maintain their assets under management. There is no doubt that significant macroeconomic risks are beginning to cloud the outlook in Europe, threatening in some cases the very existence of the Eurozone. On the other hand, many experts believe that the worst is over, and with established frameworks now in place for dealing with most perceived financial risks, little downside remains. In fact, many hedge fund managers are pointing to a higher risk tolerance in 2013 being responsible for some of the sustained gains.

Luke Ellis, President of the Man Group, told the Financial Times, “Last year and in 2011, everybody jumped at every shadow. This year, if you look at the shadows – the Italian Election, sequestration in Cyprus, things that would have caused a massive run for the doors – we have been able to ignore them.”

That said, the potential for a black swan event stretching financial stability mechanisms to the extreme still remains, and many would argue that Europe is certainly not out of the woods yet. The concentration of European funds among the strongest performers in the first months of the year does point to a reliance on further positive economic and political developments from the Eurozone. If that materializes, hedge fund returns could certainly remain elevated for 2013.

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Hedge Fund Managers Look to Asia for New Investment

December 10, 2012

With investment markets and institutional balance sheets on shaky ground in North America and Europe, hedge fund mangers are struggling to grow their assets under management in conventional markets. Institutions are looking for liquidity to meet cash obligations as well as reduce risk heading into what appears to be highly volatile market conditions. The search […]

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European Regulators Target Hedge Funds with Risky Rules

November 26, 2012

In what is becoming a fairly predictable trend, leading financial regulators are considering tightening regulations to limit global financial risk. However, recently proposed rules coming from the European Union may actually have a destabilizing impact on financial markets, despite the intention of the rules to decrease the risk that any specific institution may become too […]

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