Hedge Fund Investors More Rational Than Rash
Hedge funds are frequently criticized for adding risk and volatility to financial markets. However, a recent paper shows that they benefit financial markets by dispersing risk and contribute to stability by providing liquidity. Further, hedge fund investors are more interested in long-term returns than short-term gains.
Published by the Federal Reserve Bank of Dallas, the paper is a useful primer on the role of hedge funds in the financial system and provides clear explanations of hedge fund terms and investment strategies.
The paper says data on hedge fund performance and money flows reveal factors that enhance stability. “Longer-term performance matters for hedge fund money flows, apparently more than short-run gyrations in returns. Money flows also suggest that investors are attracted substantially by hedge funds’ performance relative to others following the same strategy, providing a cushion for funds that do relatively well in a falling market.”
Except in especially adverse circumstances, we find hedge fund investors tend to focus on longer term rather than immediate performance. In addition, they often stick with successful fund managers through a downturn. Such behavior adds stability to hedge funds’ financial bases and limits capital flight.
“We must never forget, however, that especially adverse performance can lead to more abrupt capital outflows,” the paper concludes. “All told, the links between hedge funds’ performance and money flows point to both the sources and limits of stability in today’s financial system.”
The paper, Hedge Fund Investors More Rational Than Rash, is available free of charge from the Dallas Fed website.
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October 8th, 2007 at 4:14 pm
[…] to have had hedge funds, venture capital and private equity on their minds. Our most-read post, Hedge Fund Investors More Rational than Rash, belied the conventional wisdom that hedge funds are short-term-focused slash-and-burn […]