Hedge Funds: The Misunderstood Investment Vehicle

Surprisingly enough, the financial crisis of 2008 has put a bright spotlight on hedge funds once again. In fact, Title IV of the Dodd-Frank act of 2010 places a host of additional regulations on hedge funds through modifications of the Investment Advisor Act of 1940. Yet, hedge funds had little to do with the crisis and fared better than most other investment classes. In this chapter, we examine the misunderstood asset class known as hedge funds. We review the basics of what makes a hedge fund, including legal characteristics, business characteristics, and the types of strategies that different hedge funds engage in. We also compare hedge funds with other closely related alternative assets: private equity funds and venture capital funds. We then re-examine the often-raised question of whether hedge funds add value or not and discuss whether hedge funds are really dangerous, whether they need more regulation, and whether regulations would do anything to benefit society. We find, as found in previous analyses, that hedge funds offer investors both diversification benefits and excess returns.