Hedge Funds

What are hedge funds?

Hedge funds are investment funds that are generally private, open to limited numbers of investors, and loosely regulated by the federal government. The only regulations for hedge funds are self-imposed by the fund operators in the form of a procedural document. Despite the risks of hedge funds they continue to grow in size and popularity in the United States and around the world. By the end of 2006 hedge fund assets reached $1.225 trillion in value.

How do hedge funds work?

Hedge fund unlike typical retail (public welcome) funds generally have small numbers of investors (typically pre-qualified) and can engage in a number of trading possibilities including long and short assets, futures, commodities, and derivative contracts. This creates a complex investment environment that is not for the average investor. Most hedge fund investors are financial institutions and investor partnerships. Hedge funds unlike retail funds pay performance bonuses to fund managers. The logic is that if a manager has a vested interest they will more likely to make better decisions for the fund. The managers generally receive a fee based on asset value and a management fee. Performace Most hedge funds are based in countries outside of the United States. The lack of regulation and reporting bias by fund managers means that aggregate performance statistics are impossible to gauge. This also creates an environment with near zero investor protection. A number of controversial papers and studies have been published suggesting that hedge funds typically under perform compared to market averages. However these have been rebuked by hedge funds and other financial operaters.

Hedge Fund Problems

Hedge fund failures while uncommon have devastating financial consequences. In some cases the failure can be a series of ill-timed trades and in other cases fraud may cause it to fail. The major problem with fraud is that some hedge funds do not use a third party to hold their assets which gives them the ability to misrepresent fund growth and performance to increase compensation. Several high profile cases of fraud have been publicized in recent months. The Senate Judiciary Committee has recently begun hearings concerning the propriety of hedge funds. However critics say that the SEC currently lacks the workforce and expertise to monitor the estimated 7,000 hedge funds in operation.