|
Hedge funds supplement traditional banking activities by taking on credit risks originated by the banks as well as credit risks that fall outside the purview of traditional banks.
The very word `bank' brings to the mind's eye images of oak-paneled boardrooms, counters, wads of currency, and 100-year old institutions that helped finance your college degree, granted a loan for your first car and stood by you when you were buying your first home. The term `Hedge Funds', on other hand, may bring images of unscrupulous and aggressive traders who long and short the markets, leverage their funds like there's no tomorrow, make fabulous returns in the first 3-5 years and disappear in a flash (Amaranth Advisors, Long-Term Capital Management and the like). These two terms appear to have nothing in common and probably make for strange bedfellows. However, the truth is somewhere in between, and far more profound than what meets the eye. In reality, hedge funds supplement our banking system and insulate it against market disruptions.
Hedge funds are lightly regulated pools of capital that are willing to take on diverse risks, including credit risk, the forte of traditional banks in search for higher yields. Hedge fund activities have become more sophisticated over the years evolving from simple trading of equities and bonds to undertaking complex transactions in derivatives, real estate, illiquid assets and leveraged buyout debt among others. Hedge funds supplement traditional banks' activities by taking on credit risks originated by the banks as well as credit risks that fall outside the purview of traditional banks. These trends are becoming increasingly clear and are explained in detail below. |
