Evolution of Hedge Funds : An Overview

mark tuminello hedge fund evolutionHedge funds, regardless of the name, are largely defined by their structural nature of incorporating various investment strategies and risk-management approaches, instead of their “hedging” characteristics. Hedge funds are essentially private partnerships providing the highest flexibility in establishing a portfolio. They allow provisions to make concentrated investments, use derivatives or leverage, allow investments in various markets and can be both long and short sides of the market.

In the past decade, the hedge fund industry has grown astoundingly from about 300 funds in 1990 to more than 10,000 in today’s times. It is estimated that these funds manage over $1.4 trillion in assets, onshore and offshore has is now increasingly monitored by the markets and the press. Alfred W Jones, in 1949, was the founder of the idea of hedge funds. He did so as he ‘hedged’ the market risk by short-selling and through effective use of leverage and this created led a steady trend of hedge funds outperforming mutual funds of that time.

It wasn’t until the 1960s, however, that hedge funds truly started to catch people’s eye, especially the eyes Pioneers like Warren Buffett and George Soros, who took a keen interest in Jones’ unique strategy and this led to the creation of over 130 hedge funds in the subsequent years. The attractive tendency of hedge funds, like real estate or private equity, to provide returns unlike those of traditional investments, increasingly attracted large number of institutional, and even individual investors.

In the 60s and 70s, hedge fund managers hedged their portfolios in the true sense of the word to make money on both long and short positions and in a few years, managed to make impressive profits for themselves, while delivering huge returns. Unfortunately, eventually, there were many investment professionals who saw hedge fund management as a way to make quick easy money, by bypassing the limiting infrastructure of the mutual fund industry.
Hedge fund managers today do not quite ‘hedge’ funds as much and have come a long way from Alfred Jones’ simple leverage and short-selling strategy. Many hedge funds, nowadays, take a more speculative approach and venture to achieve absolute returns.

The core investment strategy of modern hedge fund is not hedging or market risk reduction, but rather to use the right kind of leverage to optimize market’s returns in a type of inflexible bet on market swings and many such funds have earned cash-like returns with outrageous fees. These questionable strategies, says Lee Levy in his article about Hedge fund worthiness, have earned a negative reputation for the hedge fund industry in today’s market but in the end the process is all about some managers developing new ways to critically analyze the market, while the rest stay with traditional reliable methods.

The 2008 catastrophe of markets crashes all over the world led to some of the most disastrous times in the hedge fund industry. Some of the brightest and most successful managers has losses of 30 percent or more and there was a fall in the number of assets under management, since many investors switched to cash investments and even treasury bills. However, the beauty of the diverse strategies used used by hedge fund managers meant that some had implemented strategies that actually tended to have greater returns in a more erratic market and they made money for the investors, inspite of the ill-fated financial crisis. In early 2009, the industry recuperated impressively and since then has risen steadily in popularity among many investors.

Only time will tell how this regularly misunderstood, occasionally mistrusted, often rightly so, continually evolving industry will fare in the future years but it’s propensity to adjust to shifting markets points towards a rather bright one.

from Mark Tuminello http://ift.tt/1u19cnJ – latest post by Mark Tuminello

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