May 23, 2006
Are hedge funds aggressive enough?
As the hedge fund industry has grown into a multi-billion industry in the past few years, it has become the focus of increased attention both from investors and regulators. Most investors believe that hedge funds are their ticket to high returns and this belief has led just about everyone to jump onto the hedge fund bandwagon.
Everyone wants to invest in a hedge fund once they are convinced that the term is synonymous with 25 percent-plus annual returns. But this kind of return creates problems with regulators who are not convinced that the extraordinarily high returns that hedge funds earn come the right way. They believe that this mode of earning is either extraordinarily risky or crooked. Hence their eagerness to protect investors and put curbs on hedge funds.
How many investors have actually asked themselves what makes hedge funds so special? Are the high returns on investment due to certain techniques, mode of investment or is it something else. I’m sure most investors are just too happy earning their high ROIs to bother about modes and methods. But to understand how the high returns come, it is important to understand hedge funds.
One of the biggest misconceptions about hedge funds is that it can provide high returns on the invested amount. Yes, the rate of return is quite good when you compare it with mutual funds. However the ability of hedge funds to generate high returns diminishes as with larger asset holdings get larger. Today, hedge funds are estimated to be managing about a total of $1 trillion or about 7 percent of total U.S. financial net worth. And returns to large hedge funds are averaging anything between 10 and 15 percent annually. This may be high when compared to the single-digit returns on US equity markets, but not as high as it used to be when hedge funds were more aggressive.
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