Background of the Study
Financial market in USA is large and diverse, and for a long time, it has been dominated by mutual funds industry (U.S. Securities and Exchange Commission, 2003). However, in the last few decades, the trend has been changing, and today, there is growth of hedge funds industry, which is competing with mutual funds for the dominance of USA financial market. For example, in USA today, it is estimated that there are more that 7000 hedge funds, which operate in the country and manage an estimated assets amounting to over $650 billion (U.S. Securities and Exchange Commission, 2003).
Different reasons have been advanced for the growth of the hedge funds industry, and key among them is the growing interest of institutional investors such as pension plans, endowments, and foundations (U.S. Securities and Exchange Commission, 2003). The aim of these institutional investors is to diversify their portfolio in investment opportunities that reflect positive return strategies.
In addition, government regulation structure of hedge funds remains unregulated, and this has tended to eliminate numerous barriers to entry as evidenced in other funds (Hedges, 2005). This has led to mushrooming of many hedge funds as people only look up for start-up capital. At the same time, the unregulated nature of hedge funds has led to their fee remaining high, a factor that attracts new players to the hedge funds arena. Further, discouraging performance of other investment opportunities such as equity markets and mutual funds has stimulated growth of hedge funds industry. Given that people had money to invest, they had to look for alternative options that could give them better returns and this led to ‘mass’ movement into hedge funds industry (Hedges, 2005).
The definition of hedge funds remains unclear and diverse in nature, and this has led to inadequate conceptualization of the growth experienced or witnessed in this industry. Therefore, the essence of this research project will be to look at the diverse definition of hedge funds and through this, it will be possible to conceptualize the extent of growth of hedge funds, factors contributing to its growth and the impact of this sector to larger investment market in USA.
Statement of the Problem
The basic objective of most hedge funds is ingrained in the need to minimize the volatility of risk portfolio while at same time, be able to preserve capital and deliver positive returns under all market conditions (Hedges, 2005). The growth of hedge funds has, and remains elusive among many analysts given the nature of operation and organization of the industry. Hedge funds employ different strategies to realize high returns on investments and protect investors’ assets from negative effects of the dynamics of financial markets (Hedges, 2005). As a result, hedge funds add value to investors’ assets by reducing both the transaction and financial distress costs. In this way, hedge funds can be seen to play critical and productive role in a well functioning economy system where they overcome transaction costs, save time and allow market participants to economize on capital (Hedges, 2005). Value created by hedge funds to individual investors and also the financial market is great in USA, but conceptualization of the entire industry remains elusive and this has acted to block and stall the health development of this industry. Therefore, it is through conducting detailed research that key aspects accelerating growth of the industry will be identified, in addition to challenges facing the industry as well as how well hedge funds economy can influence the overall financial market in USA.
Purpose of the Study
Hedge funds industry is becoming attractive to many investors interested in obtaining alternative investment opportunities that generate positive returns. As other economy sectors like mutual funds, equity markets, and others continue to dwindle, there are numerous positive prospective identified in hedge funds. As a result, this economic sector exhibits all potential opportunities for growth. Many stakeholders are involved in hedge funds economy but the issue of information seems to be scarce in the entire sector given the regulatory nature of the industry. There is consensus that lack of information about the industry prevails among many stakeholders involved. Hedge funds as compared to other financial markets operate in ‘discrete’, where majority of fund advisers are not registered under the Advisers Act; advisers are also not subject to reporting or standardized disclosure requirements, and further, advisers are less likely to be examined by the funds’ regulatory commission (U.S. Securities and Exchange Commission, 2003). As a result of this, policy development and implementation in the industry continues to be derailed, a situation that largely dilutes the overall understanding and conceptualization of hedge funds industry. Given the role that the industry continues to platy to the larger financial market economy, it is important and necessary to develop a body of knowledge that has the capacity to inform the decision-making process in the industry. Through this, the overall benefit of the industry, growth and impact will adequately be captured, and this will be greatly informative to the large number of stakeholders involved in the industry.
Research questions constitute that part of research paper that provides an overall guidance for the research work (Hall 2008). It constitutes key areas that the research aims to answer through literature review and data collection and investigation techniques. The aim of this research paper is to assess the growth of hedge funds in USA, together with factors that have sustained this growth and the overall effects on the investment market in the US. To achieve this objective, the research will be guided by the following research questions:
- What factors/characteristics have contributed to the growth of hedge funds industry in USA?
- What is the nature of regulation in the industry and how does it impact growth?
- How can information symmetry be improved in the hedge funds industry?
- What impact does hedge funds industry has on the investment market o USA?
Research objectives of this project emanate from the research questions to be answered. As a result, the main research objective is to assess the growth of hedge funds industry in USA while at same time, be able to identify the factors that have sustained this growth process and the impact hedge funds have on the investment market. Other objectives include to establish clear aspects for the growth of hedge funds industry, establish and assess the nature of regulation environment for hedge funds in the US and how this regulation impact growth in the industry. In addition, related objectives to be achieved include identifying clear ways in which information symmetry can be enhanced in the hedge funds industry to accelerate more growth, and lastly, to establish the impact growth of hedge funds has on the investment market of the US.
Significance of the Study
It is undoubted that hedge funds have become the most appropriate alternative investment opportunity many people have directed their assets to with aim to gain positive returns. Compared to other investment alternatives, the impact of hedge fund industry is going to be great and enormous to the financial market of USA. Nevertheless, challenges present in the industry as witnessed during the financial recession makes anyone believe that just like other investment economies, hedge funds are not immune to financial problems. Therefore, health growth in the industry requires elimination of information asymmetry, which presently seems to barricade clear conceptualization of the industry. One way this can be attained is through conducting in-depth research that is premised on the objectives of defining hedge funds industry, identifying factors to its growth, analyzing the regulatory mechanisms of the industry, and finally, evaluating the challenges industry face. This undertaking will lead to availability of body of knowledge that meets academic standards, hence be able to form the basis of future policy development in the industry. At the same time, the knowledge to be produced will identify some key areas that future research work can concentrate on, in an attempt to have further understanding of the industry. On overall, the significance of this study can be perceived to reflect the need to have a more deep understanding and conceptualization of hedge funds industry, thus being able to assess its growth and impact to the wider financial market in USA.
Review of Related Literature
Definition of hedge funds
Growth of alternative investment strategies, which hedge fund is one of them can be explained through modern portfolio theory. Different aspects have been associated or linked to the growth of alternative investment strategies, and key among them is reflected in the portfolio theory. According to this theory, the tendency to diversify investment is attached to low correlation to other assets, where at the same time is perceived that it should be able to improve returns and minimize volatility over the long term, specifically at the total portfolio level (Gawron, 2007). Due to this understanding, it can be established that the increasing demand associated with alternative investments can be derived from the fact that alternative investment funds are regarded to generate absolute returns while maintaining low correlation with the traditional asset classes. On further note, it can be stated that funds that seek absolute returns constitute one that aims to achieve positive return in virtually all market environments, with less concerns originating from the nature of movements in the equity and bond markets (Gawron, 2007).
No precise consensus can be identified to have reached common ground with regard to definition of hedge funds. This has remained so for some time now, as diverse definition, characterization, and understanding of hedge funds exists. Some of these fuzziness in the definition of hedge funds can be attributed to the nature and formation of hedge funds, which again remain less understood and conceptualized. According to the words of Gawron (2007), there exists no standard legal definition of hedge fund, and many of definitions exhibit diverse and unrelated characteristics. Moreover, the author expresses that the term hedge funds should not be construed to mean that a particular fund is hedging, but it should be regarded to constitute an aspect where the fund is organized and operated. According to Jones (2008), hedge funds are a loose collection/umbrella term that includes many diverse strategies, which in essence and nature differ sharply in terms of market exposure and risk. As a result, the author provides a subjective definition of hedge funds as, “fund that is incentivized and flexible enough to generate returns irrespective of the direction of core underlying markets” (Jones, 2008, p.5). Giving this definition, the author acknowledges that there has not been a conclusive definition of hedge funds and there is less likeliness such unified definition will be realized very soon.
Hammer and Friese (2005) observe that, hedge fund as a concept still operate with no agreed definition, but in most cases, the following aspects have been regarded to constitute what hedge fund is. According to the authors, hedge fund can be construed to mean, “professionally managed pool of assets that are used to invest and trade in equity securities, fixed-income securities, derivatives, futures and other related financial instruments” (Hammer and Friese, 2005, p.1). Alongside this observation of what constitutes hedge funds, the authors continue to note that participation in hedge fund operate like closed entity that only allows relatively wealthy individuals and institutions, which are able to meet the minimum set standards of private offering requirements (Hammer and Friese, 2005). As a result, the term hedge has been adopted in order to distinguish this type of investment from other related investments such as mutual funds, venture capital funds, and private equity funds or even commodity pool that always manifests slim differences with hedge funds.
According to Hedges (2005), hedge funds can be understood to constitute alternative investments that also include investment such as venture capital and private equity funds, real estate, and commodities. As a result, the origin of the term ‘hedge’ might have come from the practice of investment managers who decided to undertake numerous and complex positions in numerous securities, thereby hedging them against the risk of general market decline, specifically through adoption of short positions in other securities (Hedges, 2005). Given this observation, the author is convinced that the term hedge funds has broader and multiple usage where it can be envisioned to constitute private investment vehicles, which, by avoiding some regulatory hiccups, have become viable investment strategies and instruments (Hedges, 2005).
It can be seen that definitions and understanding of hedge fund is likely to remain amorphous and heterogeneous, but the substance should always be to capture the nature of hedge funds and in such way, it becomes possible to conceptualize what hedge fund is. This understanding is motivated by the fact that most funds within investment markets can be classified into strategy categories depending on the process, asset class, or risk and return drivers. As a result, there is likely to be no one single or standard classification and conceptualization of hedge fund. In most cases, qualitative and quantitative steps are utilized into defining and characterizing hedge fund within the investment market.
History of hedge funds
The history of hedge funds is long, but modern association of the concept has been attached to Alfred Winslow Jones, also known as the father of hedge funds, who in 1949, established the first form of hedge fund that modern hedge funds have continued to borrow key principle aspects from this first hedge fund (Kapil, 2011). It has been established that Jones raised about $60,000, which he used $40,000 to invest and pursue strategy of investing in common stocks and hedging positions with short sales (Kapil, 2011). Jones created a hedge fund in the form of limited partnership where he involved four of his friends, and together, they established Alfred Winslow Jones Company. Accordingly, the partners with Jones as their leader designed the most unique and successful investment strategy that led to realization of enormous returns. Jones was a strategist where he put together and mixed investment style of short selling with leverage, and combined the long position with short selling of the stock to generate high returns (Kapil, 2011). This was possible after Jones decided to pay 20% incentive fee to the managing partner of the fund (Kapil, 2011).
After this initial step of success that was characterized by great risk-taking, the hedge fund industry realized enormous growth in the subsequent decade that followed. For instance, the industry was able to record promising growth of 25.30% every year (Kapil, 2011). For Jones, it was just a matter of employing and playing with different but known investment strategies, which continued to bore him and the partners’ good returns. Jones strategy was largely premised on designing simple combination investment strategy of long and short with leverage (Kapil, 2011), whereby, the investor used the leverage and shorting stocks to outperform the market largely through minimum risk exposure. During the period between 1960 and 1970, growth of hedge funds continued uninterrupted, but as returns in the sector became lucrative and tantalizing, there emerged some greedy individuals aiming to reap abnormal returns unethically. This led to such investors to initiate investment strategies like the overleveraging and taking high-risk exposures. This trend became detrimental, since in early 1980s, many established hedge funds closed down and the reason associated to the closures was adoption of inappropriate investment strategy (Kapil, 2011). As the hedge funds industry reached doldrums during this period, there emerged two prominent strategists credited to the revival and resurrection of hedge funds industry; they are George Soros of Quantum Fund and Julian Robertson of Tiger Funds (Kapil, 2011).
The second phase of growth and performance of hedge funds industry is credited to the above two individuals. It is believed that in order to bring back the industry to its earlier position of great performance, the two strategists’ devised numerous and sophisticated investment strategies, which were largely reflected in derivatives along with equity and debt instruments. In the case of George Soros, the strategist established Soros Fund Management that transformed into Quantum hedge fund, and was able to generate returns of about 30% per every year in the next two decades. On the other hand, Julian Robertson established the Tiger management fund with initial capital of $8 million, and in 1998, the capital base of the company was estimated at $23 billion (Kapil, 2011). Due to the success of these two companies, the period of 1990s experienced accelerated growth of hedge funds, as the number of investors increased. The enormous growth was witnessed in the assets under management, a trend that continued into the new millennium and by 2008, it was estimated that there were about 8000 hedge funds controlling over $1 trillion (Kapil, 2011).
Presently, hedge funds activities are enormous across USA and other parts of Europe. Furthermore, as the thrill to enter this sector remains robust, there has been tendency to raise capital required for investment, where today, it is calculated to be minimally $100, 000. Currently, there exist different categories of hedge fund investors, but the most notable ones include individuals, non-profits institutions such as endowments and foundations, pension funds, and corporations (Kapil, 2011). More so, it is the group of investors, which determines the investment strategy to be adopted. High net worth individuals have been found to be the biggest contributors to hedge fund pool while endowments and foundations are regarded to be small contributors to the fund. At the moment, some of the credited hedge funds groups in accordance to their capital base include Bridgewater Associates, JP Morgan Paulson & Co., D. E. Shaw Group, Brevan Howard, Och-Ziff Capital Management, Man AHL, Soros Fund Management, Goldman Sachs Asset Management, Farallon Capital Management, and Renaissance Technologies (Kapil, 2011).
Characteristics of Hedge Funds
It was established that the definition and overall conceptualization of the term hedge funds remains fuzzy, and this has led to numerous perspectives that try to capture the meaning and essence of the term. Nevertheless, Gawron (2007) observes that the best way to capture and construct meaning of hedge funds is to identify and analyze the different characteristics that the industry manifests. Accordingly, there exist specific characteristics that distinguish hedge funds from other alternative funds. The first aspect of hedge funds has to do with their investment returns nature, where, unlike traditional investment funds, hedge fund appears to deliver positive returns whether markets are improving or declining (Gawron, 2007). What many hedge funds companies and investors aim to achieve is absolute returns, together with capital preservation. When hedge fund is compared to the convectional funds, then particular differences can be noted such as, convectional funds aim to achieve relative returns where the success of such is measured through performance, which is relative to selected targets with less regard to whether there is fall or rise (Stowell, 2010).
The second distinguishable aspect of hedge funds has to do with short selling and leverage, which has been found only to exist in the industry and not other convectional industries. According to this aspect, hedge fund managers possess the ability to buy on leverage and sell short, where short selling is fulfilled through disposing shares they do not own in order to buy them back at a lower price in the future (Stowell, 2010). In this way, it can be observed that leverage provides opportunity for hedge fund managers to invest more than the capital of the fund by borrowing money. It has been identified that adoption of these strategies in the hedge fund industry is largely aimed at controlling risks and at the same time, be able to enhance returns. Again, it should be noted that the level and point at which they are used varies between strategies and within managers (Stowell, 2010).
The third characteristic of hedge funds has to do with the nature and extent of regulation in the industry, which seems to be different and unique when compared to other sectors. For example, in most cases, hedge funds have been organized as limited partnerships and sometimes limited companies, which encourage only investors deemed qualified by fulfilling the set minimum standards. Such standards have to do with investors having relatively substantial assets to invest and exhibiting advanced understanding of financial markets (Stowell, 2010). Moreover, the only existing requirement for hedge fund companies is to ensure some levels of disclosures and reporting have been made as outlined in the SEC regulatory framework. Beyond these requirements, hedge funds sector is seen to enjoy relative freedom and less restrictive operational environment as compared to other investment funds. In most cases, control may only limit fund leverage, short selling, and the concentration of assets, hence fund managers of hedge funds are allowed to devise different strategies they perceive to be appropriate in generating positive returns (Gawron, 2007). Given this leeway, majority of hedge fund managers tend to prefer investments in the exotic securities or derivatives and also holding concentrated positions in which case the manager possesses full conviction of success as compared to convectional fund managers who diverse investment largely in long-only portfolios (Gawron, 2007).
Another characteristic of hedge funds is the issue of transparency whereby, due to lighter regulatory obligations and measures, majority of hedge fund managers can be regarded to be less transparent, especially with regard to trading positions as compared to convectional funds (Gawron, 2007). What exists in the hedge fund sector is the ability, skills, and acquired knowledge of the fund managers to exploit the existing market inefficiencies. The disclosure of information is perceived by many managers to be detrimental where it might results into short squeezes, spread compression, or duplication of trades, thus eliminating the profit opportunities (Gawron, 2007). As a result, majority of fund managers aim to protect profit opportunities and this requires keeping vital market information secret from the larger public.
In addition, hedge fund is characterized by unique fee structure where, unlike the convectional fund investment, compensation in hedge funds is linked to investment performance. Preference for this investment performance has been associated to the need to encourage managers to limit assets under management in order to focus on positive returns, rather than on asset growth (Stowell, 2010). In contrast, convectional fund managers are rewarded for attracting more clients and more assets. In most cases, hedge fund investment charges performance fee of about 20% of investment profits above the rate of watermark (Stowell, 2010). At the same time, watermark rate is usually fixed or variable, and is seen to be additional incentive that motivates managers to put more focus on the capital preservation and absolute returns (Stowell, 2010).
Hedge Fund Strategies/Classification
Hedge funds are characterized by great heterogeneity, which can be captured in its definition. As a result, there is no single way generalization can be made about hedge funds sector due to existence of numerous and varying categories of hedge funds. As a result, classification within the industry, which has further formed the basis for the definition and conceptualization of the term hedge fund, has been developed. Nevertheless, there exists a taxonomy, which seems to enjoy wide acceptance developed, based on the trading strategies of different fund managers.
The first hedge fund strategy is the long-short equity hedge fund, also known as the equity-hedged (Gawron, 2007). This type of hedge strategy takes both long and short positions in stocks. The fund reflects aspects first established by Alfred Jones who created long-short fund. An aspect of these funds is that, they tend to hedge their positions against market risks and many fund managers adopting this strategy usually identify undervalued and overvalued stocks (Gawron, 2007). In this way, fund managers are always perceived to have pure balanced or net long or short exposure and as a result, the main strategy they are ready to pursue is equity long or short. This style has been described as the directional strategy, which is straightforward type of hedge fund strategies. Moreover, fund managers have that discretion to shift positions over time without any restrictions on the degree of net or long exposure as market conditions change (Gawron, 2007).
The second hedge fund strategy is the fixed-income arbitrage hedge funds, where fund managers employing this technique always tend to find arbitrage opportunities in the fixed-income markets. Other related strategies that may be employed within this category include hedge funds invested in multi-strategy funds, emerging markets funds, funds that trade futures contracts, and convertible arbitrage funds (Stulz, 2007). In most cases, it has been established that opportunities identified by hedge funds are often small. Furthermore, it has been found that non-directional strategies are always used, where managers operate with consistent zero exposure or within tight hands of net exposure (Stulz, 2007). At the same time, fund managers perform their investment decisions based largely on quantitative techniques that aim to realize profit from short term pricing anomalies (Stulz, 2007).
The third hedge fund strategy is the event-driven hedge fund where in most cases, fund managers attempt to exploit advantage of opportunities that have been created by significant transactional events, which in most cases may include spin-offs, mergers and acquisitions, reorganizations, bankruptcies, and other extraordinary corporate transactions (Stulz, 2007). At the same time, most event-driven strategies tend to predict the possible outcome of particular transaction as well as the optimal time at which to put capital.
The fourth strategy is the macro hedge fund, which constitutes group of strategies that aim to identify mis-priced valuations in stock markets, interest rates, foreign exchange rates, and also physical commodities and leveraged bets specifically on the expected price movements in these markets (Stulz, 2007). In an attempt to identify mis-pricing, managers always tend to employ top-down global approach, which emphasizes on predicting how global macroeconomic and political events affect the valuations of financial instruments (Stulz, 2007).
This section aims at providing the structure of the study, which will serve as a guide for the overall flow of the research. Identifying the most appropriate research design, data collection technique, setting and sample of the study, instruments, and data analysis will help in the attainment of the main goal of this research project.
Epistemology is characterized by the theory of knowledge that is found within the theoretical frame of reference constituting methodology. Constructionists’ point of view stresses that reality is constructed socially because of the experience gained by an individual from the environment. This principle suggests that subjective stance of human beings results to varying definitions of truth and reality across diverse people. Empiricism, on the other hand, is believed to be the foundation of positivism, which contends the universal and objective characteristics of reality. On the other hand, objective constitutes principle of positivism, which posits the importance of application of science in the search of truth. It is therefore proposed that this particular study will gauge on both constructionist and positivistic approach wherein scientific and rational justification shall be implemented in coordination with subjective construction of insights entailed by constructionism.
This study utilized both constructionist and positivistic paradigms, and the focal point was to derive objectivity and in-depth analysis of the study. In so doing, quantitative and qualitative approaches were applied. Through a combination of these research designs, data to be retrieved was gauged using both strength of qualitative and quantitative designs, which include the strength of validity and reliability found in quantitative approach, whereas the qualitative design offers in-depth analysis of data. In this manner, it is expected that a more robust and meaningful conclusion can be gauged by the research project. Research objectives and research questions were developed in order to set the focus of the study. For this research project, descriptive research was adopted, implying that the study gauged existing characteristics of the variables under the study within its own natural setting. Moreover, the study depicts the answers or reactions of the participants at a single point in time or the actual timeframe when the participants are engaged with the survey and interview.
Sample and Setting
Population for this study constituted all stakeholders involved in hedge fund industry, including the different types of investors, hedge fund managers, and regulatory members. A sample of 210 participants was selected using the most appropriate sampling techniques with less bias. Out of these, 70 respondents were selected from the SEC, 70 others constituted fund managers while the remaining 70 included selected client investors in hedge funds. The sample selected from the population was based on their experience with hedge funds industry. The hedge fund companies were located from the available list provided by USA Security and Exchange Commission (SEC), which has the legal mandate to regulate registration and operation of hedge funds entities. Once the hedge funds entities have been selected, the next step was to contact fund managers of the selected entities in order to seek permission from them before visitation can be arranged. Once the permission had been granted, the aim was to conduct interview with the fund managers of the various hedge fund entities who also provided contacts of some of their investor clients for further interview on them.
The principle aim of interviewing fund managers was to establish their opinion regarding the hedge fund industry, factors that have prompted growth in the industry, and what they perceive to be the impact of the industry to the investment market in the country. In the same manner, staffs at the SEC were interviewed with aim of establishing how regulatory mechanism affects hedge fund industry and whether the current regulatory framework is the appropriate for the growth of industry. Identified client investors were also interviewed to establish their experience and perception about hedge fund industry as compared to other alternative investment opportunities. At the end of the survey and interviews, the researcher was able to establish various aspects concerning; regulation of hedge fund industry, factors for the growth of the industry, risks associated with this type of alternative investment, and also the role of the industry to the investment market.
Data Collection and Instrumentation
The success of the study also depends on the reliability of data obtained throughout the course of research. In this regard, the study guarantees the accuracy, reliability, and validity of its data using effective implementation of primary and secondary data collection. Secondary data is important, as it provides greater understanding on the topic. The research studies of others help to provide vital information necessary for in-depth evaluation of history and characteristics of hedge fund industry and strategies used in the industry as compared to other alternative investment opportunities. The sources from where the secondary data was obtained include peer-reviewed journals and electronic books. Another important source of data is primary information derived from surveys and interviews. In this research project, staffs at SEC, hedge fund managers, and client investors in hedge fund were interviewed to obtain insights regarding their opinion, perception, and knowledge about hedge fund industry, regulation mechanism, growth prospects, and challenges. Interviews were reinforced by administration of questionnaires to the sample respondents and this largely aimed to provide feedback about the various variables being studied.
Appropriate research instruments were utilized whereby, the instruments consisted of quantitative survey questionnaires and telephone interviews, cover letter email, and a follow-up email. The questions for the survey were developed by the researcher with the knowledge of research questions and literature review analysis. The survey contained 13 closed-ended questions and 10 open-ended questions, which were disseminated for sample respondents to provide feedback.
Ethics of Research
Research ethics imply the cautious administration of research procedures, especially when it comes to human subjects. In this case, this study was composed of human participants, thus, observing ethical processes. Permission was sought from the regulatory board for the research proposal. After obtaining the necessary approval, finding the right settings for the study and the participants to be involved in the research was the next step. Thus, prospective hedge fund entities were gauged from the list provided by the SEC staff. To apply fairness, a random selection technique was applied. Furthermore, anonymity and confidentiality of information such as personal records, responses, and opinions was ensured. Prior to continuing with the research, it was vitally important that consent be derived from the participants. Thus, each participant was contacted by telephone to ask permission for conducting the study. Apart from this, the objective of the study was also explained to the SEC staff, hedge fund managers, and client investors for them to know the honest intention of the research. Likewise, they will be guaranteed access to the results of the study and information on best practices, which can be applied in their context.
After receiving all pertinent data obtained from the survey and interview, this information was then analyzed using appropriate statistical tools. As initial procedure, SPSS software was employed to provide easier and faster analysis of data. Thus, descriptive statistics were presented in a manner that is easy to understand. After which, interpretation of these tables are supplied. Moreover, the findings were compared with the insights and information derived from review of related literature. In this manner, comparative analysis is employed so as to verify the validity of the results and gain deeper understanding.
Results and Discussions
The size of hedge fund industry
Research data shows that conceptualization of the actual size of hedge fund industry remains confusing, but majority of the respondents (66%) estimated that the size of the industry could be measured in billions. Another 27% are convinced that the industry is large and could have assets accumulation in trillions. Only 5% expressed their confidence that the industry has assets accumulation in million, while 2% were of the view that hedge fund has assets base of less than million USA dollars. In one way or the other, these results reflects another work undertaken by Connor and Woo (N.d) who observed that the size of hedge fund economy is challenging with regard to actual estimates. As a result, the authors express that many of aggregate hedge fund data are best viewed as estimates (Connor and Woo, N.d). Conducting research in 2002, Lhabitant found out that there were about 4000-6000 hedge funds that were in existence with total asset base of about $400-600 billion (Connor and Woo, N.d). These figures showed that hedge funds were growing at an annual rate of 20% while asset base and capitalization increase by 35% every year (Connor and Woo, N.d). Accordingly, the author established that many hedge funds in the country are small and large hedge funds are the most well known and manage most of money in the hedge fund industry (Connor and Woo, N.d).
Regulation of Hedge funds
Regulation is another aspect that has remained elusive in the hedge fund industry, which again has for a long time led to prevalence of information asymmetry. Connor and Woo (N.d) assert that hedge funds are generally structured to avoid regulation and disclosure of existence of hedge fund is not mandatory. As a result, many issues still boggle the operation of hedge fund and its full exploitations opportunities are yet to be realized. Different reasons were given as to why regulation should be enhanced in the industry. Here, 45% of the respondents believe transparency is absent due to clear regulation of the industry, while 41% are of the view that fraud and misconduct have prevailed in the absence of regulation body in the industry. In addition, 6% believe services have been compromised due to lack of regulation, while another 6% contend that information asymmetry has emerged and prevailed due to absence of incompetence of available regulatory regime. The remaining 2% are of the view that their investments have been insecure in absence of regulatory regime that is efficient and functional. Again, these findings reinforce earlier findings established by the SEC in 2003.
According SEC findings, many people favored regulation of hedge fund operators as this will ensure thorough and frequent inspection and examinations of their program, which will lead in improvement (U.S. Securities and Exchange Commission, 2003). Further, regulation would results into detection and elimination of operators involved in fraud and misconduct and this will sanitize the industry. Another reason why people favored regulation was that, information symmetry would increase, as many fund managers’ will be compelled to disclose more information to clients regarding their investments (U.S. Securities and Exchange Commission, 2003).
Factors for the growth of hedge funds
SEC established in 2003 that three major reasons exist that explain profound growth of hedge funds in USA. One of the three explanations is growing interest of institutional investors such as pension plans, endowments, and foundations (U.S. Securities and Exchange Commission, 2003). Second, government regulation structure of hedge funds remains unregulated and this has tended to eliminate numerous barriers to entry as evidenced in other funds (Hedges, 2005). This has led to growth of numerous hedge funds that accumulate capital faster. Lastly, discouraging performance of other investment opportunities such as equity markets and mutual funds has stimulated growth of hedge funds industry. Given that people had money to invest, they had to look for alternative options that could give them better returns, and this led to ‘mass’ movement into hedge funds industry (Hedges, 2005).
Through the research, these aspects were found to be profound explanations to the growth of hedge industry but at same time, other reasons were identified. First, 30% of the respondents expressed that regulation of the industry and setting of minimum standards for operators had increased confidence of majority of investor an aspect that have demonstrated through their increased investment in the hedge fund. Further, other associated the growth of the industry to cropping up of more hedge funds that have friendly requirements as compared to bigger hedge funds, which seem to lock out many small investors (17%). Others cited the elimination and reduction of some restrictive barriers in the industry as key reason for the growth (19%), 34% cited the increasing transparency in the industry as the reason contributing to growth while 40% contend that the increasing diversification, emergence of new markets and opportunities constitute reasons for the growing of hedge fund industry.
What Contribution does Hedge Fund has on the Investment Market?
Precise role of hedge funds to the financial market was sparingly expressed by majority of respondents, but one aspect that recorded high percentage (68%) was that hedge funds have contributed positively to the financial markets in the country. In addition, 20% are convinced that hedge funds have contributed to increased risks associated with financial institutions while the remaining did not express clearly their position on this matter. When combining these findings with some observation made earlier, it can be deduced that hedge funds have largely created great exposure to financial institutions by being counterparties in derivatives trade (Jaeger, 2008). At the same time, short selling by hedge funds and other related activities of hedge funds has contributed to market efficiency and thereby helping to guard against the development of boom and bust scenarios in financial markets (Jaeger, 2008). In this way, hedge funds have been found to possess ability of playing critical role in helping counter unrealistic security valuations. More evidence has been established that shows that, given the short selling nature of hedge funds, they have become important as economic value specifically to financial markets and economy as a whole (Jaeger, 2008).
Recommendations and Conclusion
As a result of carrying out the research, particular aspects were identified which have been transformed into research recommendations for future actions.
- Since the establishment of the regulatory commission to evaluate, guide and instill discipline within the hedge fund industry, there has not been a conclusive study to establish the extent of compliance, change, improvement, or general evaluation of the commission’s activities. This may result into reluctance of some operators’ to implement of the regulatory requirements. Therefore, it is recommended that there is need to carry out thorough assessment and evaluation of the regulation compliance level.
- The increasing information symmetry in the hedge industry is healthy for the development and growth of the industry. Nevertheless, majority of people still lack vital information and orientation to activities of hedge fund industry. Therefore, it is recommended that education promotion and awareness activities should be adopted as some of the strategies to increase information flow in the industry.
Growth within hedge industry is enormous and the contribution of the industry to investment market is enormous. Conceptualization of hedge fund remains fuzzy but all attempts have been made to characterize and describe the industry based on unique aspects that distinguish it from other alternative investments. As a result, hedge fund employs different strategies that all have aimed at increasing and boosting returns of investor investment. Moreover, for a long time, regulation of the industry has remained uncoordinated but increasing activities of SEC seem to be bringing sanity and order in the industry. With increasing regulation, it is becoming possible to share information about investments with clients, transparency seem to have increased, service seem to be improving and overall confidence level of investors is on rise. Therefore, great developments have been achieved but it has been identified that there is still need to promote education and awareness and also conduct assessment to establish compliance level. All these should be done in recognition that hedge fund industry is here to stay and contribute positively to investment market.
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Sample of Questionnaires and survey questions
What do you understand by term the hedge fund?
What requirements have to be fulfilled before hedge fund is allowed to operate?
- Enough capital__________
- Professional documents______________
How many hedge funds are legally operating in the country?
- Less than 2000______________
- Less than 4000_______________
- Less than 7000_______________
- Over than 8000______________
How many types of hedge funds do you recognize legally?
- Over 6
What is the capital base for one to operate hedge fund?
- Any amount more than $50000
- More than 100000 but less 200000
- More than 300000 but less 500000
- Any amount more than 500000
What is the size of hedge fund in the investment economy?
- Less than million USD
- Less than billion USD
- Less than trillion USD
- Any amount in billions
- Any amount in trillions
How would you describe activities of hedge fund companies?
- Transparent D
- Riscrete ewarding
- Need improvement
What aspects attract investors to hedge fund?
- Diversify investments
- High returns in hedge funds
- Security of capital
- Non-performance of other alternative investments
How would you compare hedge funds to other alternative investment opportunities?
- Very excellent
Should hedge funds be regulated?
Which benefits will be obtained by regulating hedge funds?
- Transparency will increase
- Services will improve
- Misconduct and fraud will reduce
- Information symmetry will increase
- Investors’ investments will be more secure
What are some of the risks associated with hedge funds?
Which aspects will contribute to the growth of hedge funds?
- Increased regulation
- Registration of more hedge funds
- Elimination of restrictive barriers
- Increased transparency
- Diversified investments
Hedge fund Managers
Name of the hedge fund company
- What is hedge fund?
- Who invest in hedge funds?
- What differences are there between hedge funds and other alternative investment opportunities?
- How much should one have to invest in hedge fund?
- Why do you think investors are attracted to hedge fund and not other investments?
- What hedge fund investment strategies do you use?
- Why do you think the strategies are the best?
- Which pertinent challenges are most evident in this industry?
- What do you think will make an investor abandon hedge fund investment?
- What factors will enhance growth of the industry in future?
- What motivated you to invest in hedge fund?
- Why not the other alternative investment opportunities?
- How much have you invested in hedge fund?
- Are you ready to increase or reduce your investment in hedge fund?
- Give reasons for answer in (4)
- What role do you thing SEC is playing in the industry?
- Are their any positive gains from SEC’s efforts of regulation?
- What challenges are there in hedge fund investment?
- What should be done to improve hedge funds?
- How can you predict hedge fund industry in future?