SVM sees "stale price" danger for hedge funds

LONDON (Reuters) - Some European funds of hedge funds with a track record of smooth returns are likely to report sharp falls as investor outflows force them to price assets more accurately, says SVM Asset Management.

Investor inflows in recent years had meant there was little need for some funds to value their portfolio at realistic prices, said Colin McLean, managing director and hedge fund manager at SVM.

"When you look for that pattern across the market there are quite a number of funds in different sectors that seem to be too smooth," he told the Reuters Hedge Funds and Private Equity Summit in London.

Highly reliable returns were also a characteristic of jailed swindler Bernard Madoff's $50 billion Ponzi scheme, but McLean said such returns did not necessarily show fraud.

"You don't need to be a Ponzi fund to have that kind of effect. Generally if a fund has inflows more than matching outflows then you don't have any particular need for price discovery."

Funds of hedge funds have struggled during the current crisis partly because they have offered investors monthly liquidity, but invested in funds whose holdings have proved very illiquid and difficult to value.

"What we're finding is that funds that have risen very smoothly are then, as price discovery has happened since last August, falling away quite sharply," he said, referring to the difference between the price funds had valued assets at and the price achievable now.

He said the same problem also applied to some credit hedge funds.

"I would say, in general, for funds that have come off a very long, smooth run ... I would think there's usually the prospect of the fall being rather more ... than 20 percent ... because you're catching up on some previous price discovery." McLean said the problem would lead more funds to impose limits -- or gates -- on investor outflows.

"I think we'll find more (gates)," he said.

"As soon as it's established that it's hard to get liquidity or that some investors want out it's become a very difficult problem to be equitable for all (investors)."

(Editing by Simon Jessop)