The first hedge fund started trading in 1949, in 1968 there were 140 registered, by 1998 there were 3,000 hedge funds in the US alone, managing $800-1,000 billion US, of which 70% were borrowed funds.

US hedge funds managed as much as one trillion dollars, but this was not a huge amount compared to more conventional investors. In 1998 commercial banks invested 4.1 trillion, mutual funds 5 trillion, pension funds 6.6 trillion and insurance companies 3.7 trillion, so despite the common belief that hedge funds are starting to dominate markets, they still don't come close to what other institutional investors have under management.

In 2002, it is estimated that there are over 8,000 hedge funds, so many of them must be investing less than $US100 million. Only a handful can manage assets of more than one billion US dollars, so even the largest hedge funds are small compared to managed funds.

There is considerable turnover in the hedge fund industry. In some sectors, survival rates are appalling, for example 65% of macro funds went out of business in 1998 as shown in the table below.

Survival rates of hedge funds 1994 - 1998.

Estimates based on data provided by MAR/Hedge, my source was a van Eyk Research report on hedge funds, but van Eyk got this data from a joint research paper of US Treasury, Federal Reserve, SEC & CFTC.

These failure numbers are very high compared with conventional managed funds, though fund closures do not always necessarily lead to investors losing all their money. In Australia there are typically a few fund managers that are either bought out or simply fail to reach a size large enough for profitability, in these cases investors may have their funds returned or invested with the new manager. On the other hand, many of the failures do in fact lead to investors losing their entire investment, particularly for the funds that use greater degrees of leverage, such as macro funds.

Paradoxically, the high failure rates of hedge funds may make these investments look much less risky than they really are. When funds die they tend to then drop off everyone's screens, and may introduce a massive survivorship bias to historical databases. What this means is the savage rate at which funds go out of business ensures that if you examine the historical returns of hedge funds today, without taking into account the funds that aren't there any more, you see a much lower apparent volatility.

It may well be because of this survivorship bias that so much of the marketing material used to push hedge funds tends to show very low risk compared to traditional investments. In reality, hedge funds are a very high risk investment and it is not a good idea to put too much of your money into this asset class.