The hedge fund revolution

Over the last half decade, asset flows into hedge funds have surged, the number of funds has expanded exponentially, and new products have emerged which allow investors to obtain hedge fund exposure via structured transactions. To many, this is due to a paradigm shift in investment management and constitutes a modern financial revolution. However, to others, hedge funds are simply investment strategies that do not even merit consideration as an independent asset class. The opponents of hedge fund investing argue that performance data are misleading and that hedge funds exhibit large downside risk, lack transparency and liquidity, and are not tax efficient. They assert that one should think long and hard before making any allocation to hedge funds whatsoever. In this article I argue the contrary, making the case that hedge funds are the best-performing asset class over the past decade and more, and are likely to remain so in the near future. Furthermore, I suggest that critics often have a vested interest in maintaining the status quo of plain-vanilla stock and bond investing, hedge funds have a theoretical advantage over traditional investment approaches, and maintain that the performance-based compensation system used by hedge funds aligns the manager’s interests with those of the investor to their mutual benefit. As a result, significant commitments to hedge funds are appropriate for most investors. This should remain so, at least until that time when the paradigm shift is complete and the last of the traditionalists has accepted the advantages of hedge funds.