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The evolution and implications of Hedge Fund institutionalization

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  1. Historical Overview
  2. Institutional Investors
    1. Headline Risk
    2. Lack of Transparency & Regulation
    3. Fees
  3. Erosion of returns

Hedge funds and their managers, once obscure enigmas of the investment community, have become in the last decade household names due to their overwhelming publicity as money-hungry madmen. Part of the reason why these loosely regulated funds have drawn so much attention is because their explosive growth in assets under management has rendered them a financial force to be fully cognizant of. Indeed, hedge funds are estimated to hold some $1.7 trillion in AUM today, and one of the biggest contributors to this growth has been the entry of major institutional investors. Since 1999, when high-net worth individuals represented some 80% of hedge funds investors, institutions such as pension funds and university endowments have made their presence felt and are now estimated to represent 50-60% of all hedge fund assets (Economist). The implications of this shift in investor base are significant and will ultimately shape the direction in which the industry goes in coming years.

[...] But we don't have to welcome share and financial-market manipulators.? A public dispute between Mahathir and Soros ensued, and the hedge fund industry was left forced to defend itself from self-righteous finger pointers. The LTCM debacle that came one year later certainly didn't help bolster hedge funds' public image. Average Americans knew that these funds not only took huge risks with borrowed money, but they had now reached a size where their instability could potentially disrupt financial markets in general. [...]

[...] Absolute Returns: The Risk Opportunities of Hedge Fund Investing. Hoboken, NJ: John Wiley & Sons, Inc Leaf, Stuart, Paul Issac and Michael Waldron. ?Understanding continuing trends in hedge funds,? Evaluating and Implementing Hedge Fund Strategies. Ronald A. Lake. London: Euromoney Books pp.341-353. Lederman, Jess & Klein, Robert. Hedge Funds: Investment and Portfolio Strategies for the Institutional Investor. New York: McGraw Hill, Inc Liang, Bing. the performance of Hedge Funds.? Financial Analysts Journal Volume 55. Loomis, Carol. Jones Nobody Keeps Up Fortune. [...]

[...] To better understand why institutions like endowments and pension funds have just recently started investing in hedge funds, we must examine the following three risk factors that highlight some of the biggest challenges to institutionalization Headline Risk Headline risk refers to the risk of public embarrassment on the part of institutions that may result from major losses or even blowups of hedge funds in their portfolio. The risk of public embarrassment is, of course, equivalent to the risk of damaging a manager's reputation, which could in turn provoke frustration on the behalf of an institution's clients and pressure for managerial change. [...]

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