There is nothing that definitively marks hedge fund managers apart from other investment managers, however. Instead, all asset management firms sit on a spectrum, whether in terms of fees charged, strategies employed, or the types of vehicles offered to investors. The idea that hedge funds represent a clear, separate grouping has never been more dubious.
Depending on the definition of a hedge fund, the assets managed could range anywhere from $800bn to $3.6tn. Furthermore, we find that the $800bn figure accords more closely with the common perception of a hedge fund.
Finding a meaningful number is not only a definitional exercise but also a statistical one, subject to uncertainty. Flows into or out of what others define as the industry should therefore be viewed in the context of such error, which should be calculated and reported.
How many assets are under the management of the hedge fund industry? This is a straightforward-sounding question, and it is common to see a straightforward-looking answer: $3.6tn according to the Securities and Exchange Commission (SEC) , say, or $3.1tn according to Hedge Fund Research Inc. (HFR), a data provider .
This masks the fact, however, that there is no unambiguous boundary between what could be considered a “hedge fund” and an active fund manager. No distinct “hedge fund industry” exists.
This matters on at least two counts. First, pension schemes and other big institutional investors usually have a discrete asset allocation bucket for hedge funds. Given the definitional mess that surrounds the relevant firms, it seems probable that sub-optimal investment decisions may be being taken as a result.
A second issue concerns how asset management firm performance is assessed. There are many different hedge fund indices against which firms are benchmarked. Many of these indices, however, face similar definitional problems and can as a result be poor yardsticks for the firms that use them as a reference.
For any given definition of a hedge fund, it is not possible to determine the assets managed by that group of firms at a given moment with arbitrary precision. It is, therefore, appropriate to report the statistical errors on the estimate. Reports of the magnitude of flows of capital into and out of different types of asset management firms should be viewed in the context of these errors.
What defines a hedge fund?
Those attempting to define hedge funds usually do so by referring to a collection of characteristics. Comments submitted for an SEC “Roundtable on Hedge Funds” in May 2003 set out a range of definitions, highlighting the ambiguity around the term .
Generally, “hedge funds” are seen as:
1) Flexible in the strategies they use, with their managers employing leverage and short-selling in order to exploit situations in which they consider themselves to have an edge, while hedging exposure to other risks.
2) Subject to less regulation than, for example, mutual funds, in exchange for limiting the categories of investors they can serve.
3) Charging high fees; famously being described as “a compensation scheme masquerading as an asset class” because of their traditional fee structure, canonically a management fee of 2% of assets under management (AUM) per year, plus a performance fee of 20% of profits (“2&20”).
These eye-catching fee terms are often referred to alongside estimates of the aggregate AUM of hedge funds, which may be somewhat misleading. According to Preqin, a data provider, “only 17% of active single-manager hedge funds actually charge a strict 2% management and 20% performance fee structure” . HFR also pointed out in March that as of the end of last year, the average management fee was 1.48%, while the average performance fee was 17.4%.
Meanwhile, many funds possessing some of the characteristics listed above prefer not to describe themselves as hedge funds, and a given asset management firm may manage a combination of externally-defined hedge fund and non-hedge fund assets.
Perhaps another way of thinking about what is supposed to constitute a hedge fund is to consider those vehicles that charge both a management fee and a performance fee. We consider this in more detail in our results.
We approached the problem by examining some of the range of possible definitions. The aim was to show how each affects the size of the resulting collection of funds, while attempting to make our assumptions explicit at each stage. We also estimate the error arising from the fact that we do not have complete or simultaneous AUM figures for each fund.
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