Demystifying hedge funds
| Author | Jacqueline Irving |
| Position | IMF External Relations Department |
| Pages | 246 |
Page 246
When launched four decades ago to appeal to a select group of wealthy private individuals, the hedge fund industry went relatively unnoticed by both financial regulatory authorities and the general public. Much has since changed, however. Over $1 trillion in assets are now managed by more than 8,000 hedge funds, which share a fee structure whereby fund managers retain a portion-typically, 20 percent- of profits earned. Many funds today reach ordinary retail investors, with the minimum investment having fallen from an average $1 million to $25,000 and to as low as $2,500 for a few funds.
To increase public understanding of hedge funds, the American Enterprise Institute for Public Policy Research (AEI) is sponsoring a series of conferences. The first one, on the role these funds play in capital markets, was held June 26 and featured a panel of practitioners and academics discussing associated policy issues including prospects for regulating hedge funds and the industry's future direction. Adam Lerrick (AEI and Carnegie Mellon University) moderated the discussion.
How did hedge funds come into being? The first hedge fund was set up in 1949 as a way to use (then) innovative investment strategies to seek to minimize risk while enhancing returns. But as John Makin (Caxton Associates) explained, the industry really took off in the 1980s as an alternative to the equity-focused, benchmark-evaluated mutual and pension fund industries. The largest hedge funds emerged around major traders in volatile markets for commodities, currencies, and fixed-income instruments.
But since 2000, the role of many new hedge funds has changed radically, Makin said, with increasing numbers of investors viewing them as "a kind of octane additive" to their pension and mutual fund portfolios. Today's numerous hedge funds follow a wide range of investment strategies, with some indistinguishable from mutual funds-although hedge funds are less stringently regulated.
As with other investment activities, Makin pointed out, a moral hazard problem exists both across the industry and within hedge funds themselves. He warned that a scenario where a number of hedge funds simultaneously pursue a "shoot-for-the-moon" investment strategy could heighten systemic risk, as occurred with the collapse of major hedge fund...
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