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In the 1990s, assets managed by hedge fund industry in the US experienced an exponential growth. Assets grew from about US$40 billion in late eighties to over US$650 billion in 2003. Assets managed by mutual funds exceeded those of hedge funds; total assets managed by mutual funds are in excess of US$6.5 trillion.
Hedge fund assets continue to grow at an accelerated rate and hedge fund industry analysts have linked this expansion to the flourishing global equity markets, particularly the technology sector. However, the meltdown in the global equity markets of the past three years completely totally revolutionalized the hedge fund industry. Many Wall Street investors lost faith in the stock market as they watched the depletion of their accumulated wealth.
Asset growth in hedge fund portfolios were indirectly the result of many Wall Street investors seeking other methods of investing money, differently from the traditional “buy and hold” strategy mostly used by mainstream investment money managers . The growth of alternative investment strategies were to some degree at the expense of mutual funds, as many mutual fund companies lost significant amount of capital following the equity market decline.
The recent mutual fund/hedge fund trading scandals have implications for the growing dynamics where lines between mutual funds and hedge funds are increasingly difficult to draw. In fact, increasing popularity of hedge funds due to its absolute return strategies is slowly but steadily being noticed by mainstream investors. The creation of funds of funds shows that smaller non-qualified investors can pool their resources together to invest in hedge fund managers.
Some mutual fund companies have branched into hedge funds, claiming that their traditional investors are interested in such vehicles. When mutual fund groups create and manage hedge funds, it becomes problematic. This is because on one hand, mutual funds are supervised by the SEC, while on the other, hedge funds are usually unregulated, but they must conform to the general and broad requirements for hedge fund investors, such as qualifications etc.
These dichotomies have led to some potential conflict of interest allegations. For example, a mutual fund manager can purchase a stock that hedge fund manager may sell short. Such a scenario may lead to a situation where the mutual fund client may see heavy losses while the hedge fund client sees gains. Such problem ultimately draws the attention of the SEC and the Congress to implement new regulations governing such industries. Hopefully hedge fund’s flexibility would largely be left unharmed, because the hedge fund industry has pretty much held itself in check since the fall of LTCM of the late 90s. Additionally, hedge funds today offer a greater transparency to its investors through hedge fund online portals.
Despite the potential to provide substantial returns, it would appear conclusive that hedge funds ought to be abolished or at least highly regulated. However the issue is far more complex than one assumes. Going further, the advantages and disadvantages of preserving hedge funds are discussed.
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