Tepper School of Business
Demystifying Hedge Funds
The URL for the entire article is: http://www.aei.org/publications/pubID.24409,filter.all/pub_detail.asp
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Every day, somewhere in the global marketplace, hedge funds are shaking up the comfortable status quo and voices from high places are raised in protest. The Governor of China’s central bank Zhou tried to deflect G7 censure of the under-valuation of the yuan by pointing at unruly hedge funds as a greater threat to the world economy. In the American heartland, Warren Staley, CEO of agricultural giant Cargill, accused hedge funds of distorting fundamentals and roiling the commodities markets. In Germany and Japan, politicians denounced hedge fund corporate activists as “locusts” that destroy and disrupt in order to extract quick profits.
Are hedge funds really to blame for all the ills that befall the international financial system? Are they disruptive speculators or dispassionate agents that expose fundamental flaws and speed up inevitable change? Does their search for the highest absolute economic return eliminate inefficiencies and bring balance and liquidity to the market? Or does it lead to excessive risk-taking that may one day entrain widespread crisis?
Hedge funds are simply pools of money seeking the highest absolute rate of return across the capital markets with a management compensation structure that commands a high share of profits. They have been here for more than a generation and, like any financial innovation, are following a normal life cycle. First, a small number of pioneers garner excess profits; next, competition and capital are broadly attracted; finally, the concept moves into the mainstream, matures and is winnowed out until the risk/reward ratio approaches that of other instruments.
