Regulations for hedge funds in other countries besides the U.S.?

Regulation of hedge funds does differ when taken outside of the boundaries of the United States. However, much of the regulation on hedge funds throughout the world does resemble the regulation in the US. In Europe, for example, the primary method is to regulate the financial advisors/managers of the funds. The managers are required to register with the FSA (the Financial Services Authority). Within the European Union, there have been some differences with regulation between different countries, but the hard and fast rule is that EU fund managers are required to register.

Recently, something called the Directive on Alternative Investment Fund Managers, or AIFMD, was passed by the EU to better monitor the activities of hedge fund managers. Countries within the EU are required to adopt the practices of AIFMD by 2013. It is quite an undertaking for every hedge fund manager within the European Countries to comply with the regulations in AIFMD, but AIFMD has made certain allowances to make the transition easier. For example, they have introduced a sort of passport that enables any hedge funds authorized in a country in the EU to operate throughout the entire EU.

Obviously Europe is not the only place aside from the United States that participates in hedge fund activities. An incredibly popular option for those abroad, and even for a portion of American citizens, is to run the hedge funds through offshore locations. This includes Bermuda, the British Islands, Dublin, the Cayman Islands, and many more locations. Any hedge fund that is run through an offshore location has to comply with the individual regulations there. Offshore hedge funds are quite different from other types of hedge funds; one example of this difference is the fact that the funds are valued as net asset value (NAV), not as account balances as with domestic funds.

In South Africa, registration with and approval from the Financial Services Board (FSB) is required for hedge fund managers. Also in South Africa, much emphasis is placed on local investment rather than international. In Singapore, hedge funds are less regulated and have fewer licensing requirements than other Asian hedge fund “hot spots,” such as Hong Kong. Singapore is a popular hedge fund location for this reason.

Recently, the Dodd-Frank Act was passed in the United States. This act has wide reaching implications and may change the nature of hedge funds throughout the world. Those international hedge funds that have more than twenty-five million dollars with fifteen or more American managers or investors must register with SEC. Managers who are registered with SEC are also required to file and keep information about managed assets up to date with the SEC as well.

This is only the beginning of overseas regulation for hedge funds. However, it illustrates that there is still a focus on regulating investment managers rather than the investments themselves. Hedge funds are popular globally, and there is a good amount of cross over investment from countries with financial hubs. Some seek to take advantage of the opportunities presented by offshore accounts, but new regulation may be changing some of that activity.

Controversy and debates about hedge fund

There are several debates and controversies on the subject of hedge funds. A good deal of the debate has to do with the fact that there is supposedly systemic risk when dealing with hedge funds. Also, a good deal of attention is paid to the fact that there is very little transparency required with hedge funds, as they are considered private investments, and have limited regulation compared to other types of investments.

Critics of hedge funds have claimed that the nature of these high risk investments could lead to a domino effect in the financial sector with catastrophic results. Systemic risk refers to the collapse of the entire financial system, and so it may be difficult for some to picture one failed hedge fund or failed hedge fund company bringing the entire system down. However, people who feel that – if such a failure should happen, and it should be noted that failure has happened on scales both big and small – a major failure could occur with one hedge fund, and be seen in hedge funds that are similar. Many pro-hedge fund people debate this claim of systemic risk, because failure has already occurred in many hedge funds, and the result was that the financial system was nowhere near systemic failure. When a hedge fund does fail, they are typically leveraged low and the market as a whole can weather the failure fairly easily. In fact, dozens of hedge funds failed during the financial crisis – and there was still not systemic failure.

The other major issue that is up for debate is transparency. The lack of disclosure that is required regarding hedge funds is deeply troubling to some people, who argue that this atmosphere of secrecy can perpetuate fraud. In many cases, the investors themselves have very limited information on what the hedge fund managers are actually doing. An example of issues with transparency would be that many American hedge funds do not rely on third parties to perform crucial tasks, such as administration or acting as custodian of assets, and this has been shown to lead to conflict of interest, and in some cases even fraud. There have been several high profile arrests made of people who have engaged in fraudulent behaviors or schemes with regards to running hedge funds.

Another issue regarding hedge funds is the fact that it is extremely difficult to track performance statistics. Between the fact that the majority of hedge funds were not required to submit performance findings, and the fact that there is a restriction against public advertisement and offerings (leading to a reticence or outright refusal of fund managers to willingly put the performance information out to the public), it is incredibly difficult to comprehensively study how hedge funds perform on average. Individual funds can be studied, but many remain a relative mystery.

These are just some of the controversies and debates surrounding hedge funds. Hedge funds are a subject of some scrutiny after the financial crisis of recent years. The SEC, for example, is scrutinizing the possibility of insider trading within hedge funds; it remains to be seen, but there is always a chance that regulation will be strengthened for hedge funds.

Risks with hedge funds

The short answer to the question “are there risks with hedge funds?” is “yes.” With any type of investment, there are risks! The market is not foolproof, and there are dozens of cautionary tales for every possible type of investment. As for hedge funds specifically, the risks are incredibly varied. Because of the nature of any given hedge fund, which functions as a kind of investment portfolio and may be dealing with multiple types of investments at any given time, the risks associated are ever-changing and depend on individual hedge fund portfolios.

The main thing to remember about hedge fund risks is that the person delegated to control the fund, and to make investment decisions, should be a highly specialized and experienced money manager. Hedge fund management is not for amateurs. Hedge fund money managers must weigh their experience, knowledge, and study of the market against the goals of the investor, and must make sometimes difficult decisions. While hedge funds were initially developed as a method of reducing risk while seeking large profits, modern day hedge funds are often engaging in volatile markets. The higher the risk is, sometimes, the higher the gain is.

If the portfolio manager does end up taking “risks” by investing in a volatile market, things can be unpredictable and unsteady. This is where investors have to trust in the wisdom of their money manager. Recall that it is in the money manager’s best interests to make sound financial decisions so that they will make as much money as possible, along with the investor. Irresponsible or unskilled money managers will not have longevity in their profession, and will not be able to hold onto clients.

However, even the most responsible and thoughtful money manager with a great track record cannot predict every twist and turn of the market. What was considered a smart investment decision may ultimately fail to make profits. No one can predict the exact outcome of an investment, unfortunately, and there will be errors. If an investment does take a loss, the majority of investment partnerships will hold the money manager liable; many will not receive their performance fee, and there are often other safeguards put in place to make sure that the investor remains happy. Losing a great deal of money is always a possibility, when it comes to the world of investments, but a responsible investor who has done their research on their money manager will be prepared to weather the twists and turns of a tricky market.

Hedge funds are also generally designed to be long-term, and so an investor who sees little to no profit one year may see a substantial increase the next. The key is to remain in contact with your money manager, and yes, sometimes – if you feel they have acted irresponsibly – to perhaps take your business elsewhere. Do not make the mistake of thinking that hedge funds are “easy” money; hedge funds have been known to make people a lot of money very quickly, but that is not the case for everyone.

History of hedge funds

Hedge funds have become increasingly more well-known and popular over the last decade or so, after experiencing some historical ups and downs in terms of popularity. Hedge funds are certainly not new. This unique investment structure may have also changed a bit since its inception, but still resembles the original “model” of a hedge fund in many cases.

The person commonly credited with having “invented” the hedge fund is Alfred Winslow Jones (he also coined the term “hedged fund”). This Harvard graduate was a very remarkable man, and inventing the hedge fund was only one of his achievements. The hedge fund as we would recognize it in these modern times “debuted” in 1949, when Jones opened an equity fund as a private partnership. This did several things, and what was probably most important about it was that this merger meant the hedge fund was exempt from SEC regulation. Additionally, he combined leverage and short sales in a unique way to give him flexibility, and by doing so created a new model for investment practices. In 1952, Jones turned the private partnership into a limited partnership, and also paid a “performance fee” – these are two aspects of the modern hedge fund that are ubiquitous today.

Once Jones established (or, according to people who do not attribute the invention of the hedge fund to Jones himself, popularized) the general structure of hedge funds, they caught on. People were intrigued by the chance to invest without slavishly following the market’s trends, and also by the chance to invest in relative secrecy, not being regulated by the SEC. Throughout the following decades, hedge funds rose in popularity. By 1968, there were nearly two hundred.

Things changed during the following recession and stock market crash in the 1970s. Because of the substantial loss that the financial sector had seen, fewer people were willing and able to deal with hedge fund investments. However, by the 1980s, hedge funds had increased in popularity and were coming out of the slump of the 1970s, where the majority of hedge fund investments were single-strategy. By the 1990s, the media had popularized hedge funds more than ever before, and they were considered lucrative and full of new investors because of the stock market rise at the time. As the decade progressed, more strategies were added to the hedge fund investment “repertoire,” and hedge funds became truly and incredibly diversified.

The heyday of the hedge fund was probably in the mid to late 2000s. However, with the financial crisis at the end of the decade came a drop in popularity for hedge funds. The difficult financial times meant that a portion of hedge funds failed completely, and investor withdrawals were restricted due to liquidity issues. Despite the difficulties presented by the credit crunch/financial crisis, hedge funds continue to be popular and to thrive. Though they are often high risk, and though there will probably always be hedge fund failures, this unique type of investment continues to attract investors from around the entire world.