Editing Hedge fund (section)

==Debates and controversies==
===Systemic risk===
[[Systemic risk]] refers to the risk of instability across the entire [[financial system]], as opposed to within a single company. Such risk may arise following a destabilizing event or events affecting a group of [[financial institution]]s linked through investment activity.<ref name=NBER>{{cite journal |doi=10.3386/w11200 |title=Systemic Risk and Hedge Funds |last1=Chan |first1=Nicholas |last2=Getmansky |first2=Mila |last3=Haas |first3=Shane M |last4=Lo |first4=Andrew W |date = March 2005 |journal=NBER Working Paper No. 11200 |doi-access=free }}</ref> Organizations such as the [[European Central Bank]] have charged that hedge funds pose systemic risks to the financial sector,<ref>{{cite web |url=http://www.ecb.int/pub/pdf/other/financialstabilityreview200606en.pdf |title=Financial Stability Review June 2006 |date=June 2006 |access-date=14 August 2010 |archive-url=https://web.archive.org/web/20110629095405/http://www.ecb.int/pub/pdf/other/financialstabilityreview200606en.pdf |archive-date=29 June 2011 |url-status=live |df=dmy-all }}</ref><ref>{{cite news|url=http://business.timesonline.co.uk/tol/business/economics/article670960.ece|title=ECB warns on hedge fund risk|first=Gary|last=Duncan|author-link=Gary Duncan|newspaper=The Times|date=2 June 2006|access-date=1 May 2007|location=London|archive-url=https://web.archive.org/web/20110611232029/http://business.timesonline.co.uk/tol/business/economics/article670960.ece|archive-date=11 June 2011|url-status=dead|df=dmy-all}}</ref> and following the failure of hedge fund [[Long-Term Capital Management]] (LTCM) in 1998 there was widespread concern about the potential for systemic risk if a hedge fund failure led to the failure of its counterparties. (As it happens, no financial assistance was provided to LTCM by the [[US Federal Reserve]], so there was no direct cost to US taxpayers,<ref>{{cite magazine |last=Bookstaber |first=Richard |url=http://www.time.com/time/business/article/0,8599,1653556,00.html |title=Blowing up the Lab on Wall Street |magazine=[[Time (magazine)|Time]] |date=16 August 2007 |access-date=14 August 2010 |archive-url=https://web.archive.org/web/20101206061830/http://www.time.com/time/business/article/0,8599,1653556,00.html |archive-date=6 December 2010 |url-status=dead |df=dmy-all }}</ref> but a large [[bailout]] had to be mounted by a number of financial institutions.)

However, these claims are widely disputed by the financial industry,<ref>{{cite web |url=http://www.edhec-risk.com/edito/RISKArticleEdito.2006-07-27.4050/attachments/EDHEC%20response%20to%20ECB%20statement%20on%20HFs.pdf |title=A reply to the ECB's statement on hedge funds by the EDHEC Risk and Asset Management Research Centre |work=edhec-risk.com |access-date=14 August 2010 |archive-url=https://web.archive.org/web/20090919163149/http://www.edhec-risk.com/edito/RISKArticleEdito.2006-07-27.4050/attachments/EDHEC%20response%20to%20ECB%20statement%20on%20HFs.pdf |archive-date=19 September 2009 |url-status=dead |df=dmy-all }}</ref> who typically regard hedge funds as "[[Too big to fail|small enough to fail]]", since most are relatively small in terms of the assets they manage and operate with low leverage, thereby limiting the potential harm to the economic system should one of them fail.<ref name=mallaby>{{cite book |title=More Money Than God: Hedge Funds and the Making of a New Elite |last=Mallaby |first=Sebastian |year=2010 |publisher=Penguin Group |isbn=978-1-59420-255-1|title-link=More Money Than God: Hedge Funds and the Making of a New Elite }}</ref><ref>{{cite news |title=No Threats Here, Firms Tell the U.S. |first=Ben |last=Protess |url=https://dealbook.nytimes.com/2010/11/19/no-threats-here-financial-firms-tell-u-s/ |newspaper=The New York Times |date=19 November 2010 |access-date=28 March 2011 |archive-url=https://web.archive.org/web/20101125044716/http://dealbook.nytimes.com/2010/11/19/no-threats-here-financial-firms-tell-u-s/ |archive-date=25 November 2010 |url-status=live |df=dmy-all }}</ref> Formal analysis of hedge fund leverage before and during the [[2008 financial crisis]] suggests that hedge fund leverage is both fairly modest and [[counter-cyclical]] to the market leverage of investment banks and the larger financial sector.<ref name=AngGorovyy>{{cite journal |last1=Ang |first1=Andrew |last2=Gorovyy |first2=Sergiy |last3=van Inwegen |first3=Gregory B. |year=2011 |title=Hedge Fund Leverage |journal=Journal of Financial Economics |volume=102 |issue=1 |pages=102–126 |doi=10.1016/j.jfineco.2011.02.020 |s2cid=15596157 }}</ref> Hedge fund leverage decreased prior to the [[2008 financial crisis]], even while the leverage of other financial intermediaries continued to increase.<ref name=AngGorovyy/> Hedge funds fail regularly, and numerous hedge funds failed during the [[2008 financial crisis]].<ref>{{cite news |title=Hedge fund graveyard: 693 and counting |first=Ben |last=Rooney |url=https://money.cnn.com/2008/12/18/news/economy/hedge_fund_liquidations/?postversion=2008121817 |work=CNNMoney.com |date=18 December 2008 |access-date=5 April 2011 |archive-url=https://web.archive.org/web/20120119043803/http://money.cnn.com/2008/12/18/news/economy/hedge_fund_liquidations/?postversion=2008121817 |archive-date=19 January 2012 |url-status=live |df=dmy-all }}</ref> In testimony to the [[United States House Committee on Financial Services|US House Financial Services Committee]] in 2009, [[Ben Bernanke]], the [[Federal Reserve System|Federal Reserve]] Board Chairman said he "would not think that any hedge fund or private-equity fund would become a systemically critical firm individually".<ref>[http://www.gpo.gov/fdsys/pkg/CHRG-111hhrg55809/pdf/CHRG-111hhrg55809.pdf ''Federal Reserve Perspectives on Financial Regulatory Reform Proposals: Hearing Before the H. Comm. on Financial Services''] {{Webarchive|url=https://web.archive.org/web/20131228040910/http://www.gpo.gov/fdsys/pkg/CHRG-111hhrg55809/pdf/CHRG-111hhrg55809.pdf |date=28 December 2013 }}, 111th Cong. 25 (2009) (testimony of Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve System).</ref>

This does leave the possibility that hedge funds collectively might contribute to systemic risk if they exhibit [[Herd behavior|herd or self-coordinating behavior]],<ref name="self-coordinating behaviour">{{cite web |last1=Systemic Risk Centre |title=Engineering and the financial system |date=20 July 2015 |url=https://issuu.com/lsesrc/docs/src_final_july_2015?e=17950101/14294828 |access-date=27 November 2021 |archive-date=27 November 2021 |archive-url=https://web.archive.org/web/20211127110413/https://issuu.com/lsesrc/docs/src_final_july_2015?e=17950101/14294828 |url-status=live }}</ref> perhaps because many hedge funds make losses in similar trades. This coupled with the extensive use of leverage could lead to forced liquidations in a crisis.

Hedge funds are also closely connected to their prime brokers, typically investment banks, which could contribute to their instability in a crisis, though this works both ways and failing [[counterparty]] banks can freeze hedge funds assets, as [[Lehman Brothers]] did in 2008.<ref>{{cite book| last=Coggan| first= Philip| title= Guide to Hedge Funds| orig-year= 2008| year= 2010| publisher = The Economist| isbn= 978-1-84668-382-4| pages= 85–89}}</ref>

An August 2012 survey by the [[Financial Services Authority]] concluded that risks were limited and had reduced as a result, ''inter alia'', of larger [[margin (finance)|margin]]s being required by counterparty banks, but might change rapidly according to market conditions. In stressed market conditions, investors might suddenly withdraw large sums, resulting in forced asset sales. This might cause liquidity and pricing problems if it occurred across a number of funds or in one large highly leveraged fund.<ref>
{{cite web|url= http://www.fsa.gov.uk/static/pubs/other/hedge-fund-report-aug2012.pdf|title= Assessing the possible sources of systemic risk from hedge funds|publisher = Financial Services Authority|date= August 2012|access-date= 18 July 2013|archive-url= https://web.archive.org/web/20121110212234/http://www.fsa.gov.uk/static/pubs/other/hedge-fund-report-aug2012.pdf|archive-date = 10 November 2012|url-status = live|df= dmy-all
}}
</ref>

===Transparency===
Hedge funds are structured to avoid most direct [[financial regulation|regulation]] (although their managers may be regulated), and are not required to publicly disclose their investment activities, except to the extent that investors generally are subject to disclosure requirements. This is in contrast to a regulated mutual fund or [[exchange-traded fund]], which will typically have to meet regulatory requirements for disclosure. An investor in a hedge fund usually has direct access to the investment adviser of the fund, and may enjoy more personalized reporting than investors in retail investment funds. This may include detailed discussions of risks assumed and significant positions. However, this high level of disclosure is not available to non-investors, contributing to hedge funds' reputation for secrecy, while some hedge funds have very limited transparency even to investors.<ref>Carrie Johnson, [https://www.washingtonpost.com/wp-dyn/content/article/2006/06/28/AR2006062801909.html "Scrutiny Urged for Hedge Funds"] {{Webarchive|url=https://web.archive.org/web/20170209234404/http://www.washingtonpost.com/wp-dyn/content/article/2006/06/28/AR2006062801909.html |date=9 February 2017 }} ''The Washington Post'' (29 June 2006). Retrieved 1 March 2011</ref>

Funds may choose to report some information in the interest of recruiting additional investors. Much of the data available in consolidated databases is self-reported and unverified.<ref>Cassar, G., & Gerakos, J. (2009). Determinants of Hedge Fund Internal Controls and Fees. Retrieved from [http://www.hbs.edu/units/am/pdf/Gerakos.pdf] {{Webarchive|url=https://web.archive.org/web/20120801223141/http://www.hbs.edu/units/am/pdf/Gerakos.pdf|date=1 August 2012}}</ref> A study was done on two major databases containing hedge fund data. The study noted that 465 common funds had significant differences in reported information (''e.g.'', returns, inception date, net assets value, incentive fee, management fee, investment styles, etc.) and that 5% of return numbers and 5% of NAV numbers were dramatically different.<ref>{{cite journal | last1 = Liang | first1 = B | year = 2000 | title = Hedge Funds: The Living and the Dead | journal = Journal of Financial and Quantitative Analysis | volume = 35 | issue = 3| pages = 309–326 | doi=10.2307/2676206| jstor = 2676206 | s2cid = 154504097 }}</ref> With these limitations, investors have to do their own research, which may cost on the scale of US$50,000 for a fund that is not well-established.<ref>{{cite journal | last1 = Stulz | first1 = R | year = 2007 | title = Hedge Funds Past, Present, and Future | journal = Journal of Economic Perspectives | volume = 21 | issue = 2| pages = 175–194 | doi = 10.1257/jep.21.2.175 | citeseerx = 10.1.1.475.3895 }}</ref>

A lack of verification of financial documents by investors or by independent auditors has, in some cases, assisted in [[fraud]].<ref name=Kochan09>{{cite news |title=Hedge Fund Fraud: Hedge of darkness |first=Nick |last=Kochan |url=http://www.risk.net/operational-risk-and-regulation/feature/1516866/hedge-fund-fraud-hedge-darkness |work=[[Risk (magazine)|Risk]] |date=1 July 2009 |access-date=21 April 2014 |archive-url=https://web.archive.org/web/20140504070752/http://www.risk.net/operational-risk-and-regulation/feature/1516866/hedge-fund-fraud-hedge-darkness |archive-date=4 May 2014 |url-status=live |df=dmy-all }}</ref> In the mid-2000s, Kirk Wright of International Management Associates was accused of [[mail fraud]] and other securities violations<ref name=FieldsWhite06>{{cite news |title=NFL Stars, Charmed by Kirk Wright, Lose Millions in Hedge Fund |first=Monee |last=Fields-White |url=https://www.bloomberg.com/apps/news?pid=newsarchive&sid=asENn6__scdM |work=[[Bloomberg L.P.|Bloomberg]] |date=23 August 2006 |access-date=28 April 2014 |archive-url=https://web.archive.org/web/20140504073001/http://www.bloomberg.com/apps/news?pid=newsarchive&sid=asENn6__scdM |archive-date=4 May 2014 |url-status=live |df=dmy-all }}</ref><ref>{{cite web |url=https://www.sec.gov/litigation/litreleases/lr19581.htm |title=SEC v. Kirk S. Wright, International Management Associates, LLC; International Management Associates Advisory Group, LLC; International Management Associates Platinum Group, LLC; International Management Associates Emerald Fund, LLC; International Management Associates Taurus Fund, LLC; International Management Associates Growth & Income Fund, LLC; International Management Associates Sunset Fund, LLC; Platinum II Fund, LP; and Emerald II Fund, LP, Civil Action |publisher=Sec.gov |access-date=14 August 2010 |archive-url=https://web.archive.org/web/20090724113600/http://www.sec.gov/litigation/litreleases/lr19581.htm |archive-date=24 July 2009 |url-status=live |df=dmy-all }}</ref> which allegedly defrauded clients of close to US$180 million.<ref>{{cite news |first=Amanda |last=Cantrell |url=https://money.cnn.com/2006/03/30/markets/wright_charged/index.htm |title=Hedge fund manager faces fraud charges |publisher=Money.cnn.com |date=30 March 2006 |access-date=14 August 2010 |archive-url=https://web.archive.org/web/20091003092847/http://money.cnn.com/2006/03/30/markets/wright_charged/index.htm |archive-date=3 October 2009 |url-status=live |df=dmy-all }}</ref> In December 2008, [[Bernard Madoff]] was arrested for running a US$50 billion [[Ponzi scheme]]<ref>{{cite news | url=http://www.timesonline.co.uk/tol/news/world/us_and_americas/article5331997.ece | work=The Times | location=London | title=Wall Street legend Bernard Madoff arrested over 50 billion Ponzi scheme | date=12 December 2008 | access-date=4 May 2010 | first=Deirdre | last=Hipwell | archive-url=https://web.archive.org/web/20110614213209/http://www.timesonline.co.uk/tol/news/world/us_and_americas/article5331997.ece | archive-date=14 June 2011 | url-status=dead | df=dmy-all }}</ref> that closely resembled a hedge fund and was incorrectly<ref>Daniel A. Strachman, ''The Fundamentals of Hedge Fund Management: How to Successfully Launch and Operate a Hedge Fund'' 168 (2012).</ref> described as one.<ref>{{cite book |last=Henriques |first=Diana |date=2011 |title=Bernie Madoff, the Wizard of Lies: Inside the Infamous $65 Billion Swindle |location=Oxford, UK |publisher=Oneworld |pages=36–209 |isbn=978-1-85168-903-3}}</ref><ref>{{cite news |title=Madoff brother to plead guilty |url=http://www.belfasttelegraph.co.uk/news/world-news/madoff-brother-to-plead-guilty-16179138.html |newspaper=Belfast Telegraph |date=29 June 2012 |access-date=28 June 2012 |archive-url=https://web.archive.org/web/20120701015850/http://www.belfasttelegraph.co.uk/news/world-news/madoff-brother-to-plead-guilty-16179138.html |archive-date=1 July 2012 |url-status=live |df=dmy-all }}</ref><ref>{{cite news |title=U.S. Attorneys Recover Again for South American Investors |url=http://www.businesswire.com/news/home/20120626006758/en/U.S.-Attorneys-Recover-South-American-Investors |newspaper=Business Wire |date=26 June 2012 |access-date=28 June 2012 |archive-url=https://web.archive.org/web/20130728223430/http://www.businesswire.com/news/home/20120626006758/en/U.S.-Attorneys-Recover-South-American-Investors |archive-date=28 July 2013 |url-status=live |df=dmy-all }}</ref> Several feeder hedge funds, of which the largest was [[Fairfield Greenwich Group#Fairfield Sentry Fund|Fairfield Sentry]], channeled money to it. Following the Madoff case, the SEC adopted reforms in December 2009 that subjected hedge funds to an audit requirement.<ref>Securities and Exchange Commission, [https://www.sec.gov/rules/final/2009/ia-2968fr.pdf Custody of Funds or Securities of Clients by Investment Advisers, Release No. IA–2968] {{Webarchive|url=https://web.archive.org/web/20170825184547/https://www.sec.gov/rules/final/2009/ia-2968fr.pdf |date=25 August 2017 }} (30 December 2009), 75 Fed. Reg. 1456 (11 January 2010).</ref>

The process of matching hedge funds to investors has traditionally been fairly opaque, with investments often driven by personal connections or recommendations of portfolio managers.<ref>{{cite web|url=http://rfs.oxfordjournals.org/content/early/2013/12/21/rfs.hht079|title=Opaque Trading, Disclosure, and Asset Prices: Implications for Hedge Fund Regulation|work=oxfordjournals.org|access-date=1 May 2015|archive-url=https://web.archive.org/web/20151212004235/http://rfs.oxfordjournals.org/content/early/2013/12/21/rfs.hht079|archive-date=12 December 2015|url-status=dead|df=dmy-all}}</ref> Many funds disclose their holdings, strategy, and historic performance relative to market indices, giving investors some idea of how their money is being allocated, although individual holdings are often not disclosed.<ref>{{cite web |url=http://www.hmc.harvard.edu/docs/Final_Annual_Report_2013.pdf |title=Harvard Management Company Endowment Report |date=September 2013 |publisher=Hmc.harvard.edu |access-date=9 October 2015 |archive-url=https://web.archive.org/web/20150924030739/http://www.hmc.harvard.edu/docs/Final_Annual_Report_2013.pdf |archive-date=24 September 2015 |url-status=dead |df=dmy-all }}</ref> Investors are often drawn to hedge funds by the possibility of realizing significant returns, or hedging against [[volatility (finance)|volatility]] in the market. The complexity and fees associated with hedge funds are causing some to exit the market – [[CalPERS]], the largest pension fund in the US, announced plans to completely divest from hedge funds in 2014.<ref>{{cite news|url=http://www.hedgeweek.com/2015/03/09/219658/will-entrepreneurs-save-hedge-fund-industry|title=Will entrepreneurs save the hedge fund industry|date=9 March 2015|work=Hedgeweek|access-date=1 May 2015|archive-url=https://web.archive.org/web/20150428052518/http://www.hedgeweek.com/2015/03/09/219658/will-entrepreneurs-save-hedge-fund-industry|archive-date=28 April 2015|url-status=live|df=dmy-all}}</ref> Some services are attempting to improve matching between hedge funds and investors: HedgeZ is designed to allow investors to easily search and sort through funds;<ref>{{cite news|url=https://www.bloomberg.com/bw/articles/2013-10-30/a-dating-service-for-those-who-love-hedge-funds|title=A Dating Service for Those Who Love Hedge Funds|first=Kirsten|last=Salyer|work=Businessweek|date=30 October 2013|access-date=7 March 2017|archive-url=https://web.archive.org/web/20160307111405/http://www.bloomberg.com/bw/articles/2013-10-30/a-dating-service-for-those-who-love-hedge-funds|archive-date=7 March 2016|url-status=live|df=dmy-all}}</ref> iMatchative aims to match investors to funds through algorithms that factor in an investor's goals and behavioral profile, in hopes of helping funds and investors understand the how their perceptions and motivations drive investment decisions.<ref>{{cite web|url=http://www.bizjournals.com/sanjose/news/2014/10/28/imatchative-raises-20m-to-help-match-investors.html|title=IMatchative raises $20M to help match investors, hedge funds|date=28 October 2014|work=Silicon Valley Business Journal|access-date=1 May 2015|archive-url=https://web.archive.org/web/20150211222330/http://www.bizjournals.com/sanjose/news/2014/10/28/imatchative-raises-20m-to-help-match-investors.html|archive-date=11 February 2015|url-status=live|df=dmy-all}}</ref>

===Links with analysts===
In June 2006, prompted by a letter from [[Gary J. Aguirre]], the [[U.S. Senate Committee on the Judiciary|U.S. Senate Judiciary Committee]] began an investigation into the links between hedge funds and independent analysts. Aguirre was fired from his job with the SEC when, as lead investigator of [[insider trading]] allegations against [[Pequot Capital Management]], he tried to interview [[John J. Mack|John Mack]], then being considered for [[chief executive officer]] at [[Morgan Stanley]].<ref>{{cite news |url=https://www.washingtonpost.com/wp-dyn/content/article/2006/06/28/AR2006062801909.html |title=Scrutiny Urged for Hedge Funds |work=Washingtonpost.com |date=29 June 2006 |access-date=14 August 2010 |archive-url=https://web.archive.org/web/20121111114108/http://www.washingtonpost.com/wp-dyn/content/article/2006/06/28/AR2006062801909.html |archive-date=11 November 2012 |url-status=live |df=dmy-all }}</ref> The Judiciary Committee and the [[US Senate Finance Committee]] issued a scathing report in 2007, which found that Aguirre had been illegally fired in reprisal<ref>Liz Noyer, [https://blogs.forbes.com/streettalk/2010/05/27/scales-of-justice-look-skewed-for-rajaratnam-samberg/ "Scales Of Justice Look Skewed For Rajaratnam, Samberg"] {{Webarchive|url=https://web.archive.org/web/20110711015900/http://blogs.forbes.com/streettalk/2010/05/27/scales-of-justice-look-skewed-for-rajaratnam-samberg/ |date=11 July 2011 }} ''Forbes'' magazine (27 May 2010). Retrieved 21 February 2011</ref> for his pursuit of Mack, and in 2009 the SEC was forced to re-open its case against Pequot. Pequot settled with the SEC for US$28&nbsp;million, and [[Arthur J. Samberg]], [[chief investment officer]] of Pequot, was barred from working as an investment advisor.<ref>[http://www.whistleblower.org/press/press-release-archive/633-sec-settles-with-aguirre "SEC Settles with Aguirre"] {{Webarchive|url=https://web.archive.org/web/20110417223718/http://www.whistleblower.org/press/press-release-archive/633-sec-settles-with-aguirre |date=17 April 2011 }} [[Government Accountability Project]] (29 June 2010) Retrieved 21 February 2011</ref> Pequot closed its doors under the pressure of investigations.<ref>Larry Edelman and Saijel Kishan, [https://www.bloomberg.com/apps/news?sid=adzQGDVos7OQ&pid=20601087 "Pequot Capital to Shut Amid SEC Insider-Trading Probe"] Bloomberg News. (28 May 2009). Retrieved 19 February 2011</ref>

The systemic practice of hedge funds submitting periodic electronic questionnaires to stock analysts as a part of market research was reported by ''[[The New York Times]]'' in July 2012. According to the report, one motivation for the questionnaires was to obtain subjective information not available to the public and possible early notice of trading recommendations that could produce short-term market movements.<ref name=NYT71512>{{cite news |title=Surveys Give Big Investors an Early View From Analysts |url=https://www.nytimes.com/2012/07/16/business/in-surveys-hedge-funds-see-early-views-of-stock-analysts.html |access-date=16 July 2012 |newspaper=The New York Times |date=15 July 2012 |first=Gretchen |last=Morgenson |quote=The questions are vague but collectively give us a good sense of the analyst’s overall sentiment towards the company," the report concluded. "We find that this sentiment manifests itself in future analyst upgrades |archive-url=https://web.archive.org/web/20120716114550/http://www.nytimes.com/2012/07/16/business/in-surveys-hedge-funds-see-early-views-of-stock-analysts.html |archive-date=16 July 2012 |url-status=live |df=dmy-all }}</ref>

===Value in a mean/variance efficient portfolio===
According to [[modern portfolio theory]], rational investors will seek to hold portfolios that are mean/variance efficient (that is, portfolios that offer the highest level of return per unit of risk). One of the attractive features of hedge funds (in particular [[market neutral]] and similar funds) is that they sometimes have a modest correlation with traditional assets such as equities. This means that hedge funds have a potentially quite valuable role in investment portfolios as diversifiers, reducing overall portfolio risk.<ref name="Roadmap"/>

However, there are at least three reasons why one might not wish to allocate a high proportion of assets into hedge funds. These reasons are:
* Hedge funds are highly individual, making it hard to estimate the likely returns or risks.
* Hedge funds' correlation with other assets tends to rise during stressful market events, making them much less useful for diversification in bad times than they may appear in good times.
* Hedge fund returns are reduced considerably by the high fees that are typically charged.

Several studies have suggested that hedge funds are sufficiently diversifying to merit inclusion in investor portfolios, but this is disputed for example by Mark Kritzman who performed a mean-variance optimization calculation on an opportunity set that consisted of a stock index fund, a bond index fund, and ten hypothetical hedge funds.<ref>''Portfolio Efficiency with Performance Fees'', Economics and Political Strategy (newsletter), February 2007, Peter L. Bernstein Inc.</ref><ref>{{cite news |last=Hulbert |first=Mark |url=https://www.nytimes.com/2007/03/04/business/yourmoney/04stra.html |title=Hulbert, Mark ''2 + 20, and Other Hedge Fund Math'', ''New York Times'', 4 March 2007 |newspaper=[[The New York Times]] |date=4 March 2007 |access-date=26 November 2011 |archive-url=https://web.archive.org/web/20111209204544/http://www.nytimes.com/2007/03/04/business/yourmoney/04stra.html |archive-date=9 December 2011 |url-status=live |df=dmy-all }}</ref> The optimizer found that a mean-variance efficient portfolio did not contain any allocation to hedge funds, largely because of the impact of performance fees. To demonstrate this, Kritzman repeated the optimization using an assumption that the hedge funds took no performance fees. The result from this second optimization was an allocation of 74% to hedge funds.

Hedge funds tend to perform poorly during equity [[bear market]]s, just when an investor needs part of their portfolio to add value.<ref name="Roadmap"/> For example, in January–September 2008, the Credit Suisse/Tremont Hedge Fund Index returned -9.87%.<ref>{{cite web |url=http://www.hedgeindex.com/hedgeindex/en/default.aspx?cy=USD |title=Credit Suisse/Tremont Hedge Index web page |website=HedgeIndex.com |access-date=14 August 2010 |archive-url=https://web.archive.org/web/20100819170411/http://www.hedgeindex.com/hedgeindex/en/default.aspx?cy=USD |archive-date=19 August 2010 |url-status=live |df=dmy-all }}</ref> According to the same index series, even "dedicated short bias" funds returned −6.08% in September 2008, when [[Lehman Brothers]] collapsed.