Mark J. P. Anson, CFA, Ph.D., CPA, Esq.
Chief Investment Officer CalPERS
The term “hedge fund” is a term of art. It is not defined in the Securities Act of 1933 or the Securities Exchange Act of 1934. Additionally, “hedge fund” is not defined by the Investment Company Act of 1940, the Investment Advisers Act of 1940, the Commodity Exchange Act, or, finally, the Bank Holding Company Act. So what is this investment vehicle that every investor seems to know about but for which there is scant regulatory guidance?
As a starting point, we turn to the American Heritage Dictionary (third edition) which defines a hedge fund as:
An investment company that uses high-risk techniques, such as borrowing money and selling short, in an effort to make extraordinary capital gains.
Not a bad start, but we note that hedge funds are not investment companies, for they would be regulated by the Securities and Exchange Commission under the Investment Company Act of 1940.1 Additionally, some hedge funds, such as market neutral and market timing have conservative risk profiles and do not “swing for the fences” to earn extraordinary gains.
We define hedge funds as:
A privately organized investment vehicle that manages a concentrated portfolio of public securities and derivative instruments on public securities, that can invest both long and short, and can apply leverage.
Within this definition there are five key elements of hedge funds that distinguish them from their more ...