THE HEDGE FUND SECTOR

In Chapter 3, we discussed different types of managed funds, among which are the famously secretive hedge funds. The first hedge fund manager, Alfred Winslow Jones, started a business with $100 000 and began generating extraordinary profits through the 1950s and 1960s (Mallaby, 2010). Ever since, the industry has captured interest and generated curiosity.

The annual rich list of top hedge fund earners published by Institutional Investors features four hedge fund managers who made more than $1 billion in 2017, with other top hedge managers earning more than 65 times the median pay of CEOs from the top 100 US companies (Frank, 2018). Investors are often mesmerised by these figures and take a plunge into the sector, relying on the stature and profile of these managers, which are often enhanced by the complexities of hedge fund strategies.

The role of regulators has always been crucial in determining the development of the industry. The scant regulation was one of the main elements that paved the way for the development of the industry.

According to industry estimates in 2008, the hedge fund industrys assets under management had grown to $2.5 trillion, actually performing well during the GFC. Regulatory bodies have moved to tighten their hold over the sector due to fears that a collapsing fund may damage the entire financial system. Frauds and Ponzi schemes that emerged after the GFC, such as the Madoff investment scandal in late 2008, prompted further regulatory attention (Cumming, 2010).

Apart from the regulatory changes, the acceptability of exchange-traded funds and index funds proved detrimental to the hedge sector. In the words of Jack Bogle, investor and founder of Vanguard, In hedge fund investments, people have been paying very high fees for poor performance, which resulted in disenchantment, especially among institutional investors. The dissatisfied customers were lured into the Exchange Traded Fund (ETF) industry which offered better returns with lower fees (Chris, 2017).

Despite the fact that the hedge fund sector is glorified by the large incomes earned by its most prominent fund managers, the overall trend is not positive, with the withdrawal of major investors including major pension funds such as Calpers. The legendary investor Warren Buffett, who has always been a strong critic of hedge fund managers and their promises of outperforming the market, made a bet with the fund manager Protg Partners in 2007 that his S&P 500 index fund would beat a basket of hedge funds. Buffetts index fund earned 7.10 per cent per annum over 10 years, beating a return of 2.20 per cent per annum earned by the basket of hedge funds, winning a million dollar bet (to be donated to charity) in 2017 (Akin, 2018).

QUESTION

1. Highlight the reasons behind the success of hedge funds at the time of the sub-prime mortgage crisis.

2. What are the aspects that necessitated strong regulatory involvement in the hedge fund industry?

3. What are the factors that are causing a downturn for the hedge fund industry?