Why Are Hedge Funds So Secretive?
Hedge funds are private investment funds with little or no regulation that can adopt aggressive investment strategies to earn high returns (Logue, 2006). The Securities and Exchange Commission (SEC) has restricted the number and type of investors in hedge funds. The number of investors cannot exceed 99 and investors are required to have substantial wealth and income. Hedge funds have simple organizational structures and are managed by a small team of decision makers (Frush, 2007).
Other People Are Reading
-
Exclusivity
-
Cliquishness is one reason why hedge funds are secretive. SEC regulations stipulate that accredited investors must have earned $200,000 annually in the past two years or $300,000 with spouse, and have a net worth of $2.5 million excluding residence and cars (Frush, 2007). Hedge funds are closed to the general public. This brings an air of exclusiveness because rich and famous investors shun publicity in their public lives and private investments.
Competition
-
Hedge funds have more leeway than traditional investment funds in choosing investment vehicles. Guarding their investment strategy from competitors is another reason for the secrecy surrounding hedge funds. Hedge funds are not required to reveal performance and portfolio holdings or address shareholder questions (Logue, 2006). The trade-secrets lawsuit of Telluride Asset Management in Minneapolis against its former employee, Eric Falkenstein, supports this argument. Telluride Asset Management claimed Falkenstein wanted to use its trading techniques for a fund he wanted to start (Barnett, 2008).
-
Shady Practices
-
The number of hedge funds has increased, as has competition among them. This has lead to new investment strategies that are ethically and legally questionable. Hedge funds' "event-driven" strategies are a case in point. Hedge funds hire lawyers to gather court intelligence on product liability, bankruptcy and patent litigation. They hope the information advantage can earn them a premium before the news is divulged. In some cases, it is beside the point who wins; they expect market overreaction to the verdict and adjust their moves to cash in (Liu, 2007).
Turmoil
-
The ruthless drive for profits makes the hedge fund world dirty and vengeful. The sexual harassment lawsuit by Andrew Z. Tong against a SAC Capital trader, Ping Jiang, is an example of this. Tong, a junior trader, claimed that Jiang had told him his trading method required traders "not to be too aggressive" and to be "more effeminate" and directed him to take female hormones. Tong claimed "emotional and physical distress" because of taking the hormones (Gasparino, 2007).
Complexity
-
Conventional finance theory cannot fully explain a hedge fund's sources of return. This is another reason why hedge funds have the reputation they do. Hedge funds face diverse sources of risk and hence various sources of return. The shortcomings of conventional risk measures in capturing these sources of risk lead to investor confusion and the perception that hedge funds have opaque practices (Jaeger and Pease, 2005).
-
