According to reports, around 100 hedge funds that used Lehman Brothers as their prime broker had positions held via the bankrupt Wall Street firm frozen on Monday.

While several hedge funds had already moved balances from Lehman to rivals, those that remain with the bank face uncertainty and potential liquidation of assets.

GLG Partners, one of the largest hedge funds in Europe, has had a longstanding relationship with Lehman, which is a big shareholder of GLG. Other funds in which Lehman's had stakes include D.E. Shaw, Spinnaker Capital and Ospraie Management.

The US investment bank’s failure has also triggered a rethinking among many funds regarding the riskiness of their prime brokers, with some worried about the lack of the backing of a well-capitalised commercial bank for some brokerages.

Future growth of the industry could be affected as funds are forced to de-lever and sit on large cash balances as a result of the severe pressure on the prime brokers they largely depend on for financing.

The collapse of Bear Stearns and Lehman Brothers has forced hundreds of hedge funds that used them as their prime brokers to look elsewhere for their funding and operational support but has also put pressure on funds to rein in the amount of leverage they employ.

However, Angus Murray, head of alternatives fund provider Castlestone Asset Mangement, questions whether this will affect the overall growth of the hedge fund industry.

“I don’t think the growth prospect of the global hedge market is in doubt, “ he said. “There is without doubt concern at the moment that a number of hedge funds (and we have seen this already) will go out of business.

“This is good for the business as a whole and was probably needed. Many of the hedge funds that will go out of business did not have the right risk management systems in place or simply used too much leverage. But you can see this in their results. The managers that have controlled risk and have good results will do very well when confidence returns to the market.”

Murray acknowledged that many funds now employ less leverage than previously, but believes the impact of the collapse of first Bear Stearns and now Lehman Brothers will not be significant:

“It is true that many funds have less leverage today. This is because they feel it is required. They don’t really know what is happening and would prefer not to lose money at this time and because they need to have larger margin deposits with prime brokers. But Bear Stearns and Lehman Brother were never very large in terms of market share so the effect is not as large as might be thought.”

There have also been concerns expressed about hedge funds fees, but Murray thinks that investors only question fees when performance is poor.

“If performance is good - Brevan Howard is up 16% YTD and our fund Porcupine Global Marco is up 12% YTD - then investors won’t question fees. I think most of these investors would be pretty please to have these results and pay our fees.”





He concluded: “We will go through a period of consolidation. There will be more redemptions but this money has to be put to work at some point and it will be reinvested. The greatest risk to the investor is holding too much cash when the markets begin to rise. We will probably only see this after the market (equities and commodities) recover 10%."

Hedge funds worldwide declined for a third month in August, with all strategies posting negative returns, as global equities and commodity prices dropped amid heightened concerns about the global economy, according to Eurekahedge.

The Eurekahedge Hedge Fund Index, which tracks the performance of 2,408 funds that invest globally, declined 1.4%, based on preliminary figures from the Singapore-based hedge-fund research and publishing company.

The index fell 2.1% in July and has dropped 3.4% this year. The first half of 2008 saw the fewest new hedge funds in nine years and the highest number of liquidations, Eurekahedge said.

"Going into September, we see most major markets trending in a similar fashion to that seen in August, with equities across the board being volatile and negative,'' Eurekahedge said in a statement.

A separate report by Hedge Fund Research earlier this month showed hedge funds fell for a third consecutive month in August, pushing them closer to the first losing year since 2002, because of losses in emerging-market stocks and commodities.

The HFRI Fund Weighted Composite Index fell 1.37% extending its year-to-date loss to 4.83%, according to data compiled by Chicago-based Hedge Fund Research.