Hedge Funds
Alfred W. Jones is credited with creating the first hedge fund in 1949, and since then these funds have developed as an alternative investment choice for qualified, sophisticated private investors. The growth of this industry has been particularly brisk over the past few years, as investors have increasingly discovered the innate benefits of diversification and risk management - benefits that many hedge funds can offer.

While there are many differences between hedge funds and mutual funds, including differences in fees, liquidity, expenses and regulatory oversight, one of the most noticeable is the flexibility hedge funds are allowed in terms of how they can invest their assets. From amplifying returns through leverage to hedging risk with derivatives, hedge funds have more options in the way they can invest their capital. In fact, the variety of available hedge fund strategies far exceeds the range of strategies offered by mutual funds, thus potentially allowing a wider variety of investors, with different philosophies, to invest in the specific approach they believe best meets their needs.

In addition to the potential advantages that hedge funds can offer certain investors, they also present opportunities to benefit the broader capital markets. One way that hedge funds can benefit the markets is by providing liquidity. The recent exit of many large financial institutions from various financial markets has greatly reduced liquidity in some of these markets and, in many cases, hedge funds have stepped in to fill the void. As a result, hedge funds now play larger roles in an increasing number of markets. Hedge funds now have a large presence in activities ranging from market-making to insurance underwriting, venture capital investing and trading convertible bonds, among others. With capital under management in excess of $3 trillion, hedge funds often significantly improve market liquidity around the world. Not only can this added liquidity help to reduce irrational price shocks, but the many hedge funds that continuously stand ready to buy and sell securities at competitive prices also help ensure tighter markets for all market participants.

Perhaps the most important market function performed by hedge funds is to provide a means for flexible capital deployment among various markets. The flexibility that these firms have in appropriating their funds helps to improve markets by efficiently moving capital among them. The presence of this flexible capital improves cross-market efficiency in ways that many mutual funds cannot. By dynamically deploying capital, hedge funds try to make it available where it would be most useful, which helps to ensure the efficient use of financing and can promote the overall growth of the economy.

In spite of the many benefits offered by the majority of hedge funds, there have been a few notable and unfortunate high-profile scandals that have created negative publicity for the industry. While few and far between, these examples have received a significant amount of media attention and rightly highlight the potential for abuse at the hands of unscrupulous or inexperienced managers and/or naïve clients.