ONE of the biggest popular misconceptions about the hedge fund industry is that it is unregulated and wishes to stay that way. Not only are managers vigorously and effectively regulated at a UK level, but they will soon also be subject to EU regulation, with the Alternative Investment Fund Managers Directive (AIFMD) soon to be approved by the European Council.
With new EU regulation approaching on areas like derivatives and short-selling, it’s worth remembering why the hedge fund industry is a good thing. The traditional defence of the industry is that it provides liquidity and price discovery to markets, and that is all true.
But the industry actually has an important social role and provides value to the broader economy, beyond facilitating market efficiency.
For example, the industry provides a lot of jobs, both directly (for managers) and indirectly (for advisers and service providers like lawyers and accountants) – about 40,000 in total in the UK alone, according to our research. It generates significant tax revenues too – we think about £3bn a year. That’s not chump change in these times.
And because it is increasingly institutional investors like pension funds who make up the majority of assets managed, the industry has an important social role as the guardian of people’s pensions, of university endowments and charitable investments.
Hedge funds do a good job protecting and growing those socially valuable investments because the investment strategies it employs – like short-selling – allow it to “hedge” and help prevent losses when markets fall. That’s why the industry delivers such solid returns for its investors.
The figures suggest that institutional investment now makes up about two-thirds (and rising) of all assets being managed by the hedge fund industry. These institutional investors do extensive due diligence on the hedge fund managers they appoint. If they think it’s worth investing in hedge funds, surely it is worth listening to them?
And there is another important market function hedge funds provide. They assume risk on behalf of other participants who are less able to do so.
It’s better for everyone if risk is dispersed among lots of small, diverse players, rather than concentrated among a few big guys who all do similar things. The “biodiversity” that hedge funds provide actually helps reduce systemic risk and thus prevents financial instability. Andrew Baker is chief executive of the Alternative Investment Management Association.