What Is the Role of “Hedge Funds” in the Financial Market?

What is the role of “hedge funds” in the financial market?

“Hedge fund” is a term used to describe a diverse group of financial institutions, which play an important role in our financial system. There is a wide variety of definitions given for a hedge fund. Money Central Investor defines it as “a risky investment pool…that seeks very high returns by taking very great risks”, and Goldman Sachs & Co. adds that they “use of investment and risk management skills to seek positive returns regardless of market direction.” (Lhabitant, 2002: p14) There has been rapid growth in the number of hedge funds and their assets under management, suggesting they provide economic value to investors that is not available in other investment instruments.

Their main aim is to reduce risk and volatility whilst attempting to preserve capital and deliver positive returns under all market conditions. They used a range of aggressive methods to invest in a wide array of assets to generate returns which have a very low correlation with traditional asset classes, creating a diversifying effect on a portfolio. This means they get a constant level of return, regardless of what the market does.

Hedge funds tend to be illiquid as investors are limited in terms of when and how much money they are able to take out, therefore they are long term propositions. Originally, hedge funds were not subject to the public disclosure or regulatory reporting requirements that apply to other financial institutions, thus they had little or no regulatory oversight. But since the financial crisis, more regulations have been introduced, such as reporting under AIFMD; The Alternative Investment Funds Managers Directive. Also, from February 2014, they will have to report under Emir. Policy director in the BBA’s Capital Market and Infrastructure division, Andrew Rogan, recently said “If [funds] don’t comply with Emir, there are real consequences to how a business can use derivatives to protect itself from risk…and...