Hedge Fund Research

Over the past several years, hedge funds have attracted more controversy, excitement, and misunderstanding than any other sector of the capital markets. Politicians have accused some of the larger hedge funds of manipulating the world financial markets; the press has suggested that some hedge fund managers are wildly overpaid; and rumors of spectacular hedge fund gains and losses are the subject of financial market gossip.A greater level of control, the freedom to use almost any financial tool imaginables, and the enormous amount of money that can be made under an incentive-based fee structure are some of the reasons why top talent has made its way to hedge funds. The growth of the industry is obvious.From 1988 to 1997, the hedge fund industry's assets grew seven fold, from $4.2 billion to over $29.5 billion (see table 1.1). Over the same period, the number of hedge funds increased from 1373 to 5000. Despite their growing presence in world financial and investment circles, hedge funds are still enveloped in a veil of mystery.savvy investors have realized that superior hedge funds offer an outstanding tradeoff between risk and return-perhaps the best of and available asset class. But what are hedge funds and who runs them? How do they operate? What kind of investment opportunities do they offer and why should investors consider them? And how can institutional investors and wealthy individuals best incorporate them into their asset mix? What are benefits and what are the risks? How do investors evaluate a hedge fund and how do investors invest?The purpose of this paper is to answer these questions and share practical insight into the industry.Chapter 1 introduces the history of hedge funds. In 1949, a scholar named Alfred Winslow Jones embarked on his fifth career, establishing what later became regarded as the first hedge fund. Jones set up his fund as a general partnership in January of 1949 and converted it to a limited partnership in 1952. In addition to hedging with short sales and the use of leverage, the third major characteristic of Jones's fund was its incentive fee structure. He operated in relative secrecy for about seventeen years, but in time, his secret got out, and his system became the model for the hedge fund industry. 1966-1969: Proliferation. At the beginning of 1966, the hedge fund industry was still in its infancy with no more than a handful of Jones-style hedge funds in operation. 1969-1974:Contraction. From the spring of 1966 through the end of 1974, the hedge fund industry had ballooned and burst, but a number of well-managed funds survived and quietly carried on. 1974-1985: The New Modalities. In the decade following the 1974 market bottom, hedge funds returned to operating in relative obscurity, as they had prior to April of 1966. In the mid 1980s, Hundreds of hedge funds with specialized investing systems, bearing no resemblance to Jones's equity hedging, have been established since 1980.Chapter 2 addresses the question: what is a hedge fund? The term has no formal definition and is used interchangeably to describe both an investment structure and an investment approach. Somewhat confusingly, all of these newer funds are now considered "hedge fund". The single unifying element between Alfred Jones and many of these new funds is that all have justitied incentive-based fees with thepromise of superior performance. The important features of hedge fund structures potential investors need to consider are covered in this chapter, including: legal forms, associated documentation such as limited partnership agreements, offeringmemorandum and subscription materials, registration and regulation, fees and expenses, investment size, lockup periods, liquidity, performance and reporting,tax issues, and ERISA considerations.Chapter 3 is an introduction to the most prominent hedge fund strategies. It introduces the elements of investing that make up these approaches. This introduction is intended to provide readers a framework for understanding and comparing different st...