Myth vs. Fact

Myth: The hedge fund industry is unregulated and opaque.

Fact: Hedge funds are regulated, registered with the SEC and subject to trading restrictions.

For example, hedge funds in the U.S. are subject to regulation including:

  • Dodd–Frank Wall Street Reform and Consumer Protection Act, a bill passed in 2010, requires hedge fund advisers with $150 million or more in assets to register with the Securities and Exchange Commission.
  • Hedge funds are subject to the anti-fraud provisions of the Securities Act of 1933.
  • Only accredited investors can invest in hedge funds. Accredited investors include individuals who have a minimum net worth of $1,000,000 or, alternatively, a minimum income of $200,000 in each of the last two years and a reasonable expectation of reaching the same income level in the current year. For institutional investors, the minimum net worth is $5,000,000 in invested assets.
  • Hedge funds that have more than 499 investors must register with the SEC and must comply with quarterly reporting requirements.
  • Many funds are also under the jurisdiction of the Commodity Futures Trading Commission.

Myth: Hedge funds are over-leveraged.

Fact: Hedge fund leverage is governed largely by private relationships with prime brokers. A fund posts collateral with this prime broker to secure its trades and the broker uses its own risk matrix to determine how much to lend.

  • A third of hedge funds do not utilize leverage at all. These funds’ investment gains rose 4% over the last 12 months.1
  • Over half of all funds employed leverage between one and two times their investment capital.2
  • The average standard leverage for hedge funds remains low at 1:2.5.3
  • Larger funds are still using more leverage than others. About a quarter of funds with over $1 billion in assets recorded leverage of between two and five times in investment capital.4
  • At the height of the financial crisis, some large investment banks were leveraged at 69:1.5

Myth: Hedge funds pose a systemic risk.

Fact: Their size is small compared to the broader financial services industry

  • Hedge funds aren’t highly leveraged.
  • They aren’t susceptible to runs.
  • “We conclude that hedge funds do not currently pose systemic risk to the Australian financial system or the wider economy.” Greg Tanzer, Commissioner, Australian Securities & Investment Commission, Speech Detailing ASIC Report, September 2013
  • “I would not think that any hedge fund or private equity fund would become a systemically critical firm individually.”Ben Bernanke, Federal Reserve Board Chairman, Testimony to U.S. House Financial Services Committee, October 1, 2009

Myth: Main Street doesn’t benefit from hedge funds.

Fact: Institutional investors, like foundations, educational institutions and pensions that benefit Main Street have come to rely on hedge funds as a nimble investment tool aimed at mitigating risk to protect and grow their assets.

  • 66% of the money invested in hedge funds comes from institutions.6
  • Recent data suggests that 92% of hedge fund investors expect to either increase or maintain their current allocations to hedge funds in 2014.7
  • Improving the Quality of Life through Foundations- Foundations, with investments in hedge funds, support communities in the U.S. and around the world through improvements in education, health and economic issues as well as an emphasis on arts and cultural development.
    • For example, the Ford Foundation, whose mission is to strengthen democratic values, reduce poverty and injustice, promote international cooperation and advance human achievement held $1.8 billion in hedge fund investments at the end of fiscal year 2009, 18.4% of its total assets.8
    • Creating Educational Opportunities through Endowments – For many educational institutions, hedge funds are an important tool used to diversify their portfolios, manage risk and produce reliable returns. Hedge fund investments help these institutions fund scholarships, financial aid, research, athletics and other programs.
    • Building Retirement Security through Pension Plans- Many public and private pension plans, which rely on hedge funds to diversify their portfolios, manage risk and produce reliable returns, provide retirement security to millions of families in America and around the world.9 A number of public pension plans worldwide allocate to hedge funds, including:
      • General Motors’ (GM) pension fund increased its hedge fund investments over the past 5 years to $11.9 billion of its $87.8 billion portfolio in 2010.10
      • The $1.6B Educational Employees’ Supplementary Retirement System of Fairfax County, Virginia announced in April 2011 that it was boosting its hedge fund allocation from 5% to 8%.11
      • The New York City police pension fund has allocated an expected $159 million to hedge funds and some of New York City’s other pension funds are also exploring hedge fund investments.12
      • In May 2011, Illinois teachers formalized a rise to an 8% allocation in hedge funds.13

Myth: Hedge funds are for rich people to get richer.

Fact: Hedge funds help millions of both individual and institutional investors meet their financial goals and obligations.

  • 66% of the money invested in hedge funds comes from institutions.14

 

 


1Dow Jones News, “Hedge Funds Continue to Use Less Leverage, A Third Not At All.” (May 17, 2011)

2Dow Jones News, “Hedge Funds Continue to Use Less Leverage, A Third Not At All.” (May 17, 2011)

3Credit Suisse U.S. Monthly Chartbook, July 2013

4Dow Jones News, “Hedge Funds Continue to Use Less Leverage, A Third Not At All.” (May 17, 2011)

5Hedge Fund Survey, Bank of America/Merrill Lynch, September 2010; A. Ang, et al, “Hedge Fund Leverage,” July 5, 2010.

6Preqin Ltd., January 2014

7Preqin Ltd., January 2014

8Preqin Ltd., September 2010

9SEI/Greenwich Associates, 2009; Infovest21, 2010

10Preqin Ltd., September 2010

11HFMWeek, “Fairfax County pension mulls hedge fund increase.” 4/13/2011

12 Reuters, “NY City police pension fund OKs hedge fund stake.” 3/2/2011

13Hedge Fund Intelligence 5/3/2011 http://www.hedgefundintelligence.com/Article/2816123/Investors-Institutional-Investors-Institutional-Investors-Archive/Illinois-Teachers-formalises-rise-to-8-allocation.html

14Preqin, Ltd., January 2014