Is there – in reality – something that can be called a hedge fund with defining characteristics? If so do they apply to everything that are now called hedge funds?
Hedge fund activities are very broad. They have characteristics that are defining such as they sell securities short as well as buying them, they use leverage, they charge incentive fees in addition to management fees. I think that not every firm in any industry satisfies the entire set of characteristics. In its broadest sense, I would say that hedge funds hedge out systematic factors such as changes in stock prices or interest rates or currency rates to some extent in applying their strategies.

Some managers say there is no such thing as a single hedge fund universe – but there seem to be two – one with equity characteristics and the other with fixed income characteristics. Should these replace the tendency to have ever greater numbers of strategies?
I think that the hedge funds that do the best whether in equities or fixed income provide liquidity and risk transfer to the markets. These funds are consistent money makers. This defines their business. Other market participants are willing to provide returns to the funds if the funds, in turn, provide liquidity to the market.

Hedge fund fees are criticised by investors – do hedge funds charge correctly and are the levels of fees appropriate?
The hedge fund managers have the skills and the team to apply those skills to providing liquidity or risk transfer services to the market. Fees are charged to the capital providers to supply these skills. Capital providers may not have the ability to generate pre-fee returns similar to hedge fund managers. Therefore, in any equilibrium, hedge fund managers with superior skills should earn higher returns through fees. They can’t sell the enterprise and their ideas on the stock exchange.

Hedge funds of funds and investable indices of hedge funds are suggested as most suitable for new investors – but do these smoothing approaches miss the point of hedge fund investing?
Fund of fund managers can serve to allocate money among many hedge fund choices. They have the expertise to separate the good from the not so good hedge funds. There are now over 6,000 hedge funds around the world. Not everyone should and can make the best choices among the available hedge funds. There is a division of labour and fund of fund advisers help with portfolio allocation, construction and due diligence.

Should institutional investors be regarded as having different needs to private client investors when it comes to hedge funds. Are hedge fund providers sensitive enough to their needs?
Institutional investors have different legal needs than private clients. They are larger and can generally put more capital to work. They most likely require lower returns than private clients. Moreover, institutional investors most likely have longer horizons than private clients. Therefore, the nature of investments should be different with patient capital.

What are the reasons for the current mutual suspicion about institutional investors’ hedge fund investing by some institutions and hedge fund providers? Are these views and concerns justified in your view?
Institutional investors want more transparency than private clients. They have to satisfy their own regulators. Moreover, they have a need to measure many things. And, it is not obvious if their current technology and measurements can tell them that much. I think most of the tension arises because institutional investors have built up methodologies that apply to the long-only investing and these methods don’t really apply to hedge fund investing. As a result, it will take time for these institutions to realise that the world of hedge fund investing differs in many ways from long only investing. The main difference is that long-only investors worry about the systematic long exposures that their managers are providing them. With hedge fund investing, they should be more interested in the absolute returns that they receive and the tail risk of their hedge fund portfolios.

Hedge fund investing is hampered by unsuitable or questionable performance data. How should hedge fund performance be measured?
Hedge funds provide monthly returns to investors. The aggregating data bases might be deficient because they don’t include the entire set of hedge funds, or throw away hedge funds that go out of existence. For some over-the-counter hedge funds, it might be difficult to obtain true net asset value because the securities held are not readily traded on organised exchanges. Most fund of fund managers obtain and maintain data on their underlying funds. Obviously, hedge funds provide returns that are at times correlated with systematic exposures. These exposures should be controlled for in deciding how the fund has performed relative to them and LIBOR.

Where does risk lie in hedge fund investing? Is it due to lack of liquidity, transparency or other opacity? How should hedge fund risk be measured?
There are many risks to investing in hedge funds. The major risk in my view is that under adverse scenarios the hedge fund will experience drawdowns. These draw-downs will cause investors to leave the fund and cause other investors to lose because the fund is forced to liquidate positions at times of adverse market conditions. This will cause greater losses. So, in part, if the fund is providing liquidity to the market, it will suffer losses if it, in addition, to many others are demanding liquidity. Risk management systems are crucial.

To what extent do hedge funds need special or different regulation to other investments? Is the regulation of hedge funds moving in the right direction?
The hedge funds are regulated because they buy and sell securities. They are controlled by general laws as any asset manager. There are two sets of regulations. The first is the general laws against fraud, misrepresentation, and so on. The second set is regulation of investors themselves, self policing of the industry. A fund will loose its franchise quickly if it is not acting in the investors best interest. Here, the fund of fund investors and private investors police the funds. There have been frauds, but they have been small in number relative to the dollars and number of funds in the industry. With self-policing, we have seen a large growth in assets under management in the last 10 years. This is a sign of trust.

From the Hell’s Angels of the investment world to private banks’ parlours, the hedge fund industry development has gone through a number of phases, where do you think hedge funds currently are at and where do you think the industry is headed? Are the great days of hedge fund investing over or just starting?
Hedge funds are a young industry. We know that nothing is stable in the financial service business. As banks and broker/dealers have moved away from the principle business to the agency business (serving clients and earning a fee) talented risk managers have started on their own and have left these banks. This might change and slow the growth of hedge funds. Obviously, a delicate balance between the demand for hedge fund services and the supply of capital exists in the market place. The larger the flow of funds into the business, the lower the returns. On the other hand, with more capital, the number of talented risk managers increases, and the opportunities might broaden. Just as any business, capital will flow into it until the marginal returns are competed away.

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