Hedge fund managers use sophisticated trading strategies to generate returns that traditionally cannot be achieved elsewhere. While the techniques used may be complex, hedge funds often use commonly-traded financial securities, including stocks, to earn profits. The positions that large hedge funds have in stocks is significant enough for major investment firms to monitor, research and disclose in industry reports but less than other market participants, including mutual funds.
Hedge funds can take different positions in stocks. A long position is a vote of confidence in an equity security that the stock will increase in value. Conversely, a short position represents an expectation that a stock is overvalued and the price will subsequently fall. According to a 2011 Goldman Sachs report cited in the "Christian Science Monitor," hedge funds have positions in 3 percent of stocks as of publication. The report is based on the activity of hundreds of hedge funds.
To place in context the percentage stake that hedge funds have in stocks, it may be helpful to examine the position that other investors share in the equity asset class. According to the 2011 article in "The Christian Science Monitor," exchange-traded funds, which are a type of mutual fund, have a similar stake to hedge funds, with a 4 percent position in stocks. U.S. retail investors hold a 21 percent position in stocks via all types of mutual funds.
The positions that hedge funds take in stocks are trending toward exposure in companies with the greatest market size as of publication, according to the Goldman Sachs report cited in "The Christian Science Monitor." In the first quarter of 2011, nearly half of the positions that hedge funds had in equity shares were in companies worth more than $10 billion. Nearly a decade prior, just over one-third of hedge fund equity positions were in large-capitalization stocks.
According to a 2010 University of Notre Dame Mendoza College of Business report, hedge funds have the ability to misquote positions in equity securities for the wrongful gain of the fund. Such mismarkings may be difficult to identify given the complex nature of the strategies that hedge funds employ. Nevertheless, the report suggests that this behavior is possible and remains more likely to occur in hedge funds that are based offshore, where regulation is less stringent, and at firms that are less likely to be subject to a financial audit.
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