Hedge Fund Existential

Hedge funds defy classification—which spells trouble for broad-based attempts at regulation and risk management. Hedge funds and other alternative investments are treated as a small and specialized part of the investment universe, but in fact, they are the broad part, representing just about every possible investment strategy outside the narrow set of “traditional” investments. Hedge funds encompass all investment strategies that allow both long and short positions and that allow leverage. They span all markets, from derivatives to emerging markets to real estate. And the focus of hedge funds is dynamic—waxing and waning as new markets and classes of financial instruments arise and other markets and securities become commoditized.Therefore, treating hedge funds as a category to study or monitor is all but impossible. I argue that, in fact, there is no such class as hedge funds. Hedge funds are not a homogenous class that can be analyzed in a consistent way. The “hedge funds/alternative investments” moniker is a description of what an investment fund is not rather than what it is. The universe of alternative investments is just that—the universe. It encompasses all possible investment vehicles and all possible investment strategies less the traditional investment funds and vehicles.This all-encompassing nature of hedge funds has important implications for the study of and attempts to classify hedge funds and is critical for the attempts to regulate and provide standardized risk management for hedge funds. To study hedge funds is to study the world of investment strategies. And with so broad a classification, seeking a uniform approach to regulating hedge funds or managing hedge fund risk is tantamount to setting up a standard for regulating the entire investment universe. It is like getting a committee together to develop a single set of traffic rules to apply to all modes of transportation from pedestrians to commercial jets. Faced with so general a task, what more can one say than “Be careful”? I believe that we will discover—as we continue our attempts to study, categorize, manage, and regulate hedge funds—either that we have failed or that we have enveloped the entire world of investments under a different name.