Conclusion

Hedge funds are an exciting innovation to the range of professionally managed investment vehicles. Hedge funds concentrate almost exclusively on the speculative role of investment management, that is, the attempt to outperform the market average by superior security valuation and successful trading strategies. Hedge funds are in a sense the opposite of index tracking funds, which simply try to earn the market average return with minimal management cost. Theoretically, one can view a traditionally managed active fund as a combination of a hedge fund and an index tracking fund. The index tracking fund is the “purely passive” component and the hedge fund is the “purely active” component of the traditional active fund.

Hedge funds offer very strong incentives for the portfolio manager by linking the manager’s compensation tightly to the realised return of the fund. Hedge funds minimise information leakage and maximise flexibility by avoiding full disclosure and granting the manager very wide latitude in strategy and trading decisions. These policies differ from those of the traditional fund, which must meet regulatory guidelines intended for protection of the investment public.

Hedge funds restrict access to exempt investors only, in order to avoid these regulatory constraints. Hedge funds confront the traditional fund sector with a strong challenge. They have attracted more attention and media interest than the traditional sector, they have drawn heavily on the pool of talented fund managers due to their lucrative compensation packages, and they have attracted a very strong (but still proportionately small) flow of capital. There is also some evidence that hedge funds have outperformed on average in terms of their risk-reward profile, although this evidence is not yet conclusive. At a minimum, hedge funds have brought innovative investment strategies and a new sense of excitement to the investment community.

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