A Primer on Hedge Funds
David A. Hsieh**
* Principal, Paradigm Financial Products.
** Professor of Finance, Fuqua School of Business, Duke University.
Please send correspondence to David A. Hsieh, Fuqua School of Business, Duke University, Box 90120,
Durham, NC 27708-0120. Email: firstname.lastname@example.org. Home page:
http://www.duke.edu/~dah7/index.htm. Fax: 919-660-7961.
In this paper, we provide a rationale for how hedge funds are organized and some insight on how hedge
fund performance differs from traditional mutual funds. Statistical differences among hedge fund styles
are used to supplement qualitative differences in the way hedge fund strategies are described. Risk
factors associated with different trading styles are discussed. We give examples where standard linear
statistical techniques are unlikely to capture the risk of hedge fund investments where the returns are
primarily driven by non-linear dynamic strategies.
Institutional investors and wealthy individuals have long been interested in hedge funds as
alternative investments to traditional portfolios of assets. For over half a century of its existence, the
hedge fund industry has stayed opaque to the general investing public. Increasingly, spectacular hedge
fund activities in the last decade, such as the attack on the British Pound led by George Soros and the
recent collapse of Long Term Capital which prompted the intervention from federal regulators, have
heightened the public’s interest in the hedge fund industry. The literature on the industry has grown
substantially. The depth of the literature is still limited to showing readers “how” hedge funds are
organized juxtaposed with stylized facts that are often hard to piece together into a coherent framework.
In depth discussions can be found but are typically limited to the philosophy of a single investment style
such as the work by George Soros.
In this paper, we attempt to provide a rationale on how hedge funds are organized, an