Hedge Funds

One important reason why many talented investors have migrated from the sell side to the buy side is because so-called hedge funds have become an increasingly acceptable means of investing institutional assets. Although the term "hedge fund" means different things to different people, an informal survey of institutional investors suggests broad agreement that a hedge fund is an investment vehicle displaying at least four important attributes: (1) an investment philosophy that emphasizes the generation of satisfactory absolute (as distinct from relative) returns, (2) the flexibility to both buy seemingly undervalued securities and sell short seemingly overvalued ones, (3) a fee structure comprising a base annual fee plus a percentage of the fund's absolute gains, and (4) asset management by individuals who have invested a significant fraction of their own net worth in the fund. Investment professionals making the transition from sell side trading desks to hedge funds often find the fourth attribute refreshingly familiar, because the investment banks that dominated Wall Street for decades were partnerships whose profitability depended heavily on the returns produced by aggressive investment of their partners' own capital. Of course, the chief reason why such savvy individuals were willing to put their capital at risk is because the strategies and tactics employed were so inherently flexible (cf. attributes #1 and #2). As noted above, one reason why it is getting harder for professional investors to beat market averages is because investment techniques formerly employed by a relatively limited number of "sell side" traders are being put to increased use on the "buy side." Indeed, in contrast to just a decade or two ago, when a money manager's admission that it had "changed its stripes" (i.e., modified its approach) constituted grounds for firing, money managers today are under increasing pressure to prove that they are continually revising their approaches in response to changing opportunities and perils in financial markets.