The Importance of Hedge Funds

Cite this Article
Bill Sjostrom, The Importance of Hedge Funds, Truth on the Market (May 16, 2006),

The current issue of The New Yorker magazine includes an article about hedge funds (click here). The article mentions that hedge funds have been called locusts of the global economy, disasters waiting to happen absent regulation, and instruments of Satan. It notes that hedge funds are easy to hate. “They’re secretive, rarely making public disclosures about their investments or their performance, and so are fertile terrain for fraud and incompetence.�

The focus of the article, however, is not on bashing hedge funds. Instead, it highlights the importance of hedge funds to the financial markets.

Markets work best when investors are drawing on diverse sources of information and relying on many different kinds of tools to figure out what’s going to happen next. The sheer variety of investing strategies that hedge funds use—in contrast to mutual funds, whose managers mostly just buy stocks and bonds—enhances the diversity of markets. In the U.S. stock market, hedge funds’ willingness to sell stocks short also makes the market smarter and more efficient.

Paradoxically, some of the characteristics of hedge funds that make them seem frightening also make them valuable. Secrecy, for instance, makes it harder for hedge-fund managers to imitate what their peers are doing, a common flaw among mutual-fund managers. And, because investors in hedge funds typically have to give notice of a month or more before withdrawing their money, managers are freer to pursue contrarian trading strategies that may work only over the long term.

As the article points out, “hedge funds have been far more of a boon to financial markets than a bane.”