Research Handbooks in Financial Law series
Edited by Phoebus Athanassiou
Chapter 1: Hedge Funds – An Introduction
Ludwig Chincarini* INTRODUCTION Alternative investment vehicles are vastly misunderstood and, amongst them, hedge funds are perhaps the most grossly misunderstood. While many are those who understand what the S&P 500 or a mutual fund is, few know what ‘hedge funds’ are, apart from believing them to be evil (Braithwaite (2009)). This is ironic, considering that the first hedge fund – started in 1949 by Alfred Winslow Jones – sought to help investors. Its founder was good at selecting stocks that would perform well, but rather less skilled at predicting the direction of the market. At the time, most equity portfolios were offered as mutual funds regulated by the Securities and Exchange Commission (SEC). Most of them were prohibited from shorting stocks and, therefore, had a long exposure to the overall equity market. Thus, even if their portfolio manager was exceptional at selecting stocks, a drop in the overall market would inevitably result in a simultaneous drop in the value of its portfolio. If instead the portfolio manager could simultaneously invest in ‘good’ stocks and short-sell ‘bad’ stocks, its portfolio would be less vulnerable to overall market risk.1 Even the most sceptical investor could not deny the logic of the practice of selling stocks both short and long, which is where hedge funds derive their name * CFA, PhD, Member of the Academic Council of IndexIQ. I would like to especially thank Erin Toothaker and Coady Smith as well as Jason Blauvelt, Anthony Gonzales, Andrew Oetting, Matt Walkup, Jing Wen, and Jae Sae...
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