"Although I also read a history of hedge funds by Sebastian Mallaby and blogged about it here, I am still quite unclear as to how this key new financial institution got off the ground and became so powerful." DK
I have a layman's account of where the term came from. The directions in which so called hedge funds originated and have gone is quite another matter.
Hedging was shorthand for protecting an investment with another investment which would offset a loss in the original investment.
One view of what is called diversification in an investment portfolio is merely another way of talking about a sort of generalized hedging of all one's investments, on the theory that movements in the financial market takes sectors in turn, so that a diversified portfolio protects the investor from catastrophic losses due to having put his eggs only in one basket.
Of course, this diversification theory fails in bear, recession, or catastrophic crashes, because virtually all sectors plummet together. But brokers want investors to buy as many stocks and bonds as they can, and keep on buying.
Of course, this diversification theory fails in bear, recession, or catastrophic crashes, because virtually all sectors plummet together. But brokers want investors to buy as many stocks and bonds as they can, and keep on buying.
The options markets developed also in some respects as investment vehicles for gamblers, and profit centers for financial insiders, but also as hedging opportunities for investment banks, where one buys one investment as a hedge against a corresponding loss in another. In this sense, it is really another species of diversification, or perhaps better, 'countervailing investment'.
Of course with leveraged investments, of underlying securities or of options, an element of risk is reintroduced, which often cuts against so called hedging or diversification agendas themselves.
With inside information, however, any kind of investment risk, especially in the short term, and critically with leveraged options, is reduced.
I should point out, also, as an aside, that seldom, if ever, has the insider community itself, been able to predict, protect against, or bet on a crash of the market itself.
Perhaps the classic recent example is the crash of 2008, initiated by the bubble in mortgage backed securities, chronicled by Lewis in The Big Short, where the investment bankers themselves lost their ass too, and were bailed out by the government.
I should point out, also, as an aside, that seldom, if ever, has the insider community itself, been able to predict, protect against, or bet on a crash of the market itself.
Perhaps the classic recent example is the crash of 2008, initiated by the bubble in mortgage backed securities, chronicled by Lewis in The Big Short, where the investment bankers themselves lost their ass too, and were bailed out by the government.
Michael Lewis could explain all this much better than this.
When the government bails out banks, it is the big big hedge fund, and so, in a sense, banks are protected, hedged, by their size and importance, from catastrophic loss, ab initio. Not so the individual investor.
When the government bails out banks, it is the big big hedge fund, and so, in a sense, banks are protected, hedged, by their size and importance, from catastrophic loss, ab initio. Not so the individual investor.
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