Hedge Funds - Boon or Bane?

Author: Jose D. Roncal And Jose N. Abbo

Anyone following the financial news has likely heard opinions right and left about what's behind the current crisis. In addition to the usual suspects-Wall Street greed, lack of oversight, and predatory lending-you've doubtless seen fingers pointed at other culprits, such as short selling and hedge funds.



Let's take a closer look at those last two subjects by answering these questions: What exactly are hedge funds? How do they work? Who is eligible to invest in them? And finally, why have these funds been grabbing headlines during the recent Wall Street crisis?



First, let's examine what they are and where they came from.



Hedging against risk



Back in 1949, Alfred W. Jones, a sociologist, author, and financial journalist, came up with a revolutionary idea for an investment fund. To hedge against potential losses for investors, Jones combined leverage and short-selling of securities. He was so successful at hedging the market, his fund outperformed the mutual funds of the day-and the term "hedge fund" was born.



Despite his success, hedge funds didn't really get traction until the 1960s when wealthy entrepreneurs like Warren Buffet and George Soros got on board. Suddenly hedge fund became a Wall Street buzzword, and by some estimates, these funds currently manage close to $3 trillion in assets.



While Jones's strategy focused on short selling and leverage, there are a variety of other methods today's hedge fund managers use.