Somehow the entire alternative investment trading universe, including both investment managers and their different funds, has wound-up being known as ‘hedge funds’. This nomenclature is still inappropriately used with a negative connotation.
We have had to explain to clients and and our wide network of outside agents that the name hedge fund is first of all is completely wrong….
Names are important because the public debate about financial regulation can be over-simplified, and basic words with emotional connotations can drive the results. Most people know what a bank is – they can see the branch or go to a site to conduct transactions. Most probably don’t know what an investment bank is – maybe a big bank with no branches? These views influence how we think when we hear the words ‘bank’ and ‘investment bank’, and how politicians and the press describe financial issues.
Most people have never seen a hedge fund and, worse, the name is unhelpful and confusing.
Private equity funds and venture capital funds have accurate and descriptive names. It is clear and obvious what both these types of investments are about. Even so, ‘venture’ funds sound somehow good and positive – surely they help new and exciting ventures. But private equity seems possibly mysterious and private. The Alternative Investment Fund Managers Directive (AIFMD) recognises these differences in perception, and gives preferential treatment to ‘venture’ funds, even though they are certainly as financially motivated as private equity funds.
JPMorgan’s recent trading losses have brought to light the question whether the trades were just ‘hedging’ other positions held by the bank, or rather ‘directional’ or ‘expressing a view’. More sophisticated news articles mention portfolio hedging, country hedging and hedging individual positions. On the other hand, some reports claim they were running a hedge fund inside the bank. In this case, using the word ‘hedge’ to mean the opposite of hedging: a pool of money funding a trading operation taking direct risks.
Clearly, the general meaning of hedging is understood: transactions or strategies that protect against movements in other holdings. ‘Hedging your bets’ is an easily understood expression for taking some positions that can pay-off if others don’t. The older fashioned diversification reminder was ‘don’t put all your eggs in one basket’ – another way to think about hedging.
‘Hedge fund’ would appear to imply a ‘hedged’ fund. But that is a vast over-simplification of the strategies employed by different alternative managers in their trading. Hedge funds may not be hedged at all, or if they are, only for specific risks or positions. If any were fully hedged, they wouldn’t have any return nor any investors.
We like to call alternative investments, which take short positions or other positions that are expected to move in the opposite direction of their main investments (negative correlation), hedge funds. This differentiates them from long-only or non-hedging funds. These funds may or may not use these positions to hedge other positions, however. So calling them hedge funds can be misleading and confusing to some clients and consultants.
To improve perception, we like to describe the funds activities — explain what, if anybeneficial, hedging takes place. Aware of the negativity associated with the term hedge fund, we get people thinking about the positive aspects of alternative investments. Think of ‘creative’ or ‘balanced’ investing’ or even ‘efficient capital allocation’. All those sound better and are more accurate than hedge fund, and help people better understand.