Chapter 1

Hedge fund taxonomy

It is hard to make sweeping statements about hedge funds. Some take extravagant risks; others control risks carefully. Some love to be in the public eye; others would be mortified by a mention in the Wall Street Journal or Financial Times. Some deal in exotic instruments such as credit derivatives; others simply buy and sell shares like an ordinary fund manager.

That is why commentators have to be careful before pronouncing that hedge funds are buying oil, or that hedge funds have lost a bundle in the Japanese stockmarket. For every hedge fund on one side of the trade, there is likely to be another that is betting in the opposite direction. It is at once a source of strength and of weakness for the sector. The strength is that a market fall is highly unlikely to ruin all hedge funds. In August 2007, when everyone was concerned about a financial crisis, the average hedge fund lost just 1.3%, according to Hedge Fund Research. But the weakness is that, if hedge funds are on both sides of the table, their activities sound increasingly like a zero sum game – a game for which investors are paying extremely high fees.

The sheer variety of hedge funds means that investors need to be careful about what they are buying. The freewheeling style of George Soros or Julian Robertson (who ran the Tiger funds) is far less common these days. The institutional clients of the industry (pension funds, university endowments and private banks) like funds that do “what it ...

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