A hedge fund is a private investment fund open to a limited range of investors which is permitted by regulators to undertake a wider range of activities than other investment funds and which pays a performance fee to its investment manager. Although each fund will have its own strategy which determines the type of investments and the methods of investment it undertakes, hedge funds as a class invest in a broad range of investments, from shares, debt and commodities to works of art.
As the name implies, hedge funds often seek to offset potential losses in the principal markets they invest in by hedging their investments using a variety of methods, most notably short selling. However, the term "hedge fund" has come to be applied to many funds that do not actually hedge their investments, and in particular to funds using short selling and other "hedging" methods to increase rather than reduce risk, with the expectation of increasing return.
“We'll see a tidal wave of hedge fund closures before the end of 2008,” said David C. Saunders, founding managing director of K2 Advisors LLC, Stamford, Conn. K2 manages $7.4 billion in hedge funds of funds. Mr. Saunders said smaller firms will be hard-pressed to survive a triple whammy: poor performance that has dropped 90% of funds below their high-water marks, resulting in no performance fee income; large redemption requests that will force portfolio liquidations at fire-sale prices, further dropping performance; and rising costs for everything from utilities to accounting, administrative, information and compliance services.
The pending hedge fund collapse provides another example of how unregulated businesses lacking most any kind of oversight or transparency will eventually create a disaster not only for themselves for the overall economy. From the NY Post:
Some of the industry's smartest investors got hammered over the summer amid nearly unprecedented volatility. Oil went from close to $150 a barrel to below $100 a barrel in a matter of weeks, while stocks were roiled by a series of bank failures. And a formerly winning strategy - shorting stocks - kept getting hampered by new rules from the Securities and Exchange Commission. Then came September, which is shaping up to be the worst month on record, comparable only to a decline of 8.7 percent in August 1998, when Long-Term Capital Management imploded, according to Hedge Fund Research Inc.
