Hedge Fund Management
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Industry Overview
The US hedge fund industry includes about 9,000 companies with combined annual revenue of $60 billion. Almost all hedge funds are private companies. The industry is fragmented, as large size is often an impediment to high investment returns.
Competitive Landscape
Demand for hedge fund services is driven by the growth of investment capital managed by institutional investors. The profitability of individual funds depends on investment expertise. Large funds can more easily participate in big financial transactions. Small funds can compete effectively through specialized investment strategies. The industry is highly automated.
Hedge funds are unregulated investment pools that, unlike mutual funds, can engage in a wide variety of investment activities. Hedge funds are typically organized, marketed, and operated by an individual or institution that also serves as the fund's investment adviser.
Products, Operations & Technology
Hedge funds operate much like mutual funds, but are also able to trade financial derivatives and to take "short" positions. In contrast, mutual funds can own only registered securities such as stocks and bonds. Hedge funds typically specialize in a particular type of investing, such as stocks, bonds, commodities, futures contracts, distressed securities, mergers and acquisitions, arbitrage, or investing in other funds.
The daily operations of a hedge fund depend on the particular investment strategy it follows. Funds that specialize in arbitrage may use computer programs to automatically make hundreds or thousands of trades per day. Funds that specialize in mergers and acquisitions may extensively research possible acquisition candidates. Some hedge funds are characterized by intricate investment strategies devised through sophisticated data analysis, but others merely buy and hold traditional stocks and bonds.
To access various securities exchanges, hedge funds need an arrangement with one or several securities broker-dealers who are members of the exchanges. Broker-dealers provide services such as execution of trades, custody of securities, securities lending for "short" sales, and margin lending. Broker-dealers may also introduce hedge funds to potential investors and provide a variety of administrative and advisory services.
The strategy of a hedge fund is devised and executed by the fund's investment adviser, who is usually the fund's organizer and operator. The adviser may be an individual or an institution. The investment adviser typically charges an annual investment management fee of 1 to 2 percent of the assets, and typically receives a share of profits (an "incentive allocation") of about 20 percent.
Disclosure of information to investors in hedge funds is often limited to the initial private placement memorandum (PPM) that typically describes in very general terms the types of investments a fund may make, and to account statements that may be prepared quarterly or annually. Investors are typically restricted in their ability to withdraw money from a hedge fund. Typically, funds are organized as limited partnerships, with the organizer and investment adviser as general partner.
Many hedge funds use computer technology extensively, both to analyze information to devise an investment strategy and to execute trades. Funds may have large and ongoing investments in computer and communication equipment. Funds that trade heavily may be connected directly to trading systems.