July 31 (Bloomberg) -- Jeremy Grantham, the money manager who oversees $150 billion as chairman of Grantham, Mayo, Van Otterloo & Co. LLC, said credit-market declines may force as many as half of all hedge funds to close in the next five years.

The loss of investors' appetite for risk also may cause at least one global bank and ``one or two'' of the largest private- equity firms to go out of business, Grantham, known for his pessimistic outlook, said yesterday. The 68-year-old investor said he's still bullish on emerging-markets stocks.

Hedge-fund firms such as Boston-based Sowood Capital Management LP have collapsed as investors shun riskier debt including subprime mortgages and loans to fund buyouts. Bill Gross of Pacific Investment Management Co. in Newport Beach, California, said on July 24 he sees ``severe ramifications'' for some investors who had benefited from cheap borrowing costs.

``Probably the most stretched silly credit that ever walked the face of the earth was subprime, and that was the start of it,'' Grantham said in an interview in his Boston office. ``And then you started to see more of the fixed-income market getting contagion.''

A total of 717 hedge funds closed last year, leaving 9,800 in business, according to Chicago-based Hedge Fund Research Inc. Fund raising by new hedge funds was hurt by the September collapse of Greenwich, Connecticut-based Amaranth Advisors LLC, which lost $6.6 billion betting on natural-gas prices.

Spreads Rise

Hedge funds are largely unregistered pools of capital that cater to wealthy individuals and institutions and allow managers to participate substantially in profits from investments. They control about $1.74 trillion, more than double the amount five ago.

The extra yield, or spread, that investors demand to own U.S. junk bonds rather than U.S. Treasuries rose to about 4.28 percentage points on July 27, the highest in two years, according to index data compiled by Merrill Lynch & Co. in New York.

Securities firm Bear Stearns Cos., also based in New York, said investors will get little, if any, money back from two funds that bet on bonds backed by subprime loans, while Sydney- based hedge-fund firm Basis Capital Management Ltd. has frozen investor accounts.

`Piling on Risk'

Hedge funds are ``piling on risk of different kinds and presenting it as outperformance,'' Grantham said. ``In a weak world, they pay the price of all the risk they've taken. And that is, they melt down.''

Federal Reserve Bank of St. Louis President William Poole, in a response to a question, said on July 25 that he doesn't expect losses from defaults on subprime mortgages to spread beyond the real-estate industry.

Grantham, whose firm managed as much as $6.1 million for U.S. Vice President Cheney in 2005, correctly predicted a crash in technology stocks two months before the bubble burst in March 2000. He helped start Grantham, Mayo, Van Otterloo in 1977.

Grantham said investors putting money into private-equity funds will lose most of their money because of the amount of leverage used in deals and profit-sapping fees. An overload of debt will sink at least a couple ``very large'' firms. He didn't say which firms may be imperiled.

``These guys are in a big hole,'' he said. ``Most of the money going into private equity today will be a total loss.''

Buyout firms use a mix of their own funds and borrowed money to make acquisitions.

Private-equity takeovers of companies such as Dollar General Corp. and Alliance Boots Plc have taken on more debt than investors can tolerate. Kohlberg Kravis Roberts & Co., the New York-based firm behind the Alliance and Dollar General bids, failed to find financing for its buyout of Alliance, the U.K.'s biggest pharmacy chain.

`Perma-Bear'

Dubbed a ``perma-bear'' by some colleagues for his dour view on U.S. equities for more than a decade, Grantham said he has never been so bearish. In April, he wrote a quarterly letter to investors saying the world is in the midst of a ``global bubble.''

``I have been extremely bullish on emerging-market equities for a long time, but it won't stay like this forever,'' he said.

Grantham said he still has more of his portfolio in emerging markets relative to benchmarks. His firm manages the $13 billion GMO Emerging Markets Fund, which has climbed 51 percent in the past year to beat 80 percent of rivals, according to research firm Morningstar Inc. in Chicago.

To contact the reporter on this story: Sree Vidya Bhaktavatsalam in Boston at sbhaktavatsa@bloomberg.net

Last Updated: July 31, 2007 13:44 EDT