Edited by Phoebus Athanassiou
Chapter 12: Hedge Funds and their Impact on Systemic Stability
Maria Strömqvist* INTRODUCTION ‘Hedge fund’ is a collective term for different types of investment fund. Generally speaking, a hedge fund is a fund with absolute return targets for financially sophisticated investors. Although many hedge funds protect their investments against losses (so-called hedging) this does not apply to all hedge funds, which, in fact, use many different investment strategies. Hedge funds do, however, have a number of common characteristics that distinguish them from other types of fund. In general, hedge funds employ more flexible investment strategies, in search for ‘absolute returns’. Currently, a more liberal regulatory framework than for mutual funds enables hedge funds to pursue more dynamic investment strategies, with both long and short positions and the use of derivatives. Hedge funds can also choose to have a higher level of leverage compared to other types of fund. Mutual funds have a relative return target, where the result of the fund is compared against a designated index. Hedge funds, on the other hand, have an absolute return target, irrespective of the development of the market as a whole, their goal being to achieve a return that has a low correlation with traditional risk factors such as stock- and bond indices. The part of the return that is independent from the risk premiums in the financial markets is known as alpha and it can be calculated as a residual.1 Even if the goal of hedge funds is to be market neutral, research has shown that most hedge funds have some...
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