Hedge Funds: Past, Present, and Future

H edge funds often make headlines because of spectacular losses or spectacular gains. In September 2006, a large hedge fund, Amaranth, reported losses of more than $6 billion apparently incurred in only one month, representing a negative return over that month of roughly 66 percent. Earlier in the year, newspapers focused on the $1.4 billion compensation in 2005 of hedge fund manager Boone Pickens and the 650 percent return that year of his BP Capital Commodity Fund (Anderson, 2006b). The importance of hedge funds in the daily life of financial markets does not make the same headlines, but hedge funds now account for close to half the trading on the New York and London stock exchanges (Anderson, 2006a). Chances are that you personally cannot invest in a hedge fund. Most U.S. investors cannot. Hedge funds are mostly unregulated. These funds can only issue securities privately. Their investors have to be individuals or institutions who meet requirements set out by the Securities and Exchange Commission, ensuring that the investors are knowledgeable and can bear a significant loss. Most likely, however, you personally can invest in mutual funds, which are heavily regulated in how they can invest their funds, how their managers can be paid, how they are governed, how they can charge investors for their services, and so on. The typical mutual fund cannot make the investments that provide the performance of Amaranth or the BP Capital Commodity Fund. The economic function of a hedge fund is exactly the same as the function of a mutual fund. In both cases, fund managers are entrusted with money from