The SEC estimates there are 8,800 hedge funds operating in the US but, because they are usually incorporated offshore, it is impossible to be certain. Last month an appeal court threw out a rule requiring funds with more than 15 clients, or $30m, to register with the regulator. Ruling on a lawsuit brought by Philip Goldstein, the manager of the hedge fund Opportunity Partners, the court said the requirement was arbitrary.
A hedge fund is an investment fund that pools capital from a limited number of accredited individual or institutional investors and invests in a variety of assets, often with complex portfolio construction and risk management techniques. It’s administered by a professional management firm, and often structured as a limited partnership, limited liability company, or similar vehicle. Hedge funds are generally distinct from mutual funds as their use of leverage is not capped by regulators and distinct from private equity funds as the majority of hedge funds invest in relatively liquid assets.
The name “hedge fund” originated from the paired long and short positions that the first of these funds used to hedge market risk. Over time, the types and nature of the hedging concepts expanded, as did the different types of investment vehicles. Today, hedge funds engage in a diverse range of markets and strategies and employ a wide variety of financial instruments and risk management techniques.
Hedge funds are made available only to certain accredited investors and cannot be offered or sold to the general public. As such, they generally avoid direct regulatory oversight, bypass licensing requirements applicable to investment companies, and operate with greater flexibility than mutual funds and other investment funds. However, regulations passed in the United States and Europe after the financial crisis of 2007–08 were intended to increase government oversight of hedge funds and eliminate certain regulatory gaps.
While hedge funds have existed for many decades, and become increasingly popular, growing to be one of the world’s largest asset management classes by 2014,[8] according to a report by Hedge Fund Research, published in October 2015, hedge fund industry assets shrank “by $95 billion to 2.87 trillion in the third quarter, making this their worst year since 2008. One of the best performing hedge funds in 2014 — William Ackman’s Pershing Square Holdings portfolio which had roughly $20 billion earlier in 2015 — declined by 12.6 percent by October to $16.5 billion in assets.
Hedge funds are most often open-ended and allow additions or withdrawals by their investors (generally on a monthly or quarterly basis).[1] A hedge fund’s value is calculated as a share of the fund’s net asset value, meaning that increases and decreases in the value of the fund’s investment assets (and fund expenses) are directly reflected in the amount an investor can later withdraw.
Many hedge fund investment strategies aim to achieve a positive return on investment regardless of whether markets are rising or falling (“absolute return”). Hedge fund managers often invest money of their own in the fund they manage, which serves to align their own interests with those of the investors in the fund. A hedge fund typically pays its investment manager an annual management fee (for example 1% of the assets of the fund), and a performance fee (for example 20% of the increase in the fund’s net asset value during the year). Some hedge funds have several billion dollars of assets under management (AUM). As of 2009, hedge funds represented 1.1% of the total funds and assets held by financial institutions. As of June 2013, the estimated size of the global hedge fund industry was US$2.4 trillion.
Photo credit: Alexandre Prévot via Visual Hunt / CC BY-NC-SA
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