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.