Can Hedge Funds Deliver as they Grow?

March 31, 2011

Hedge funds, by nature, are a risky investment proposition.  Nevertheless, as the market recovers, hedge funds are recovering with it.  Here is a good article from Reuters that shows how as hedge funds grow, their ability to better serve their clients is in danger.

Hedge funds need to be flexible to adequately move its holdings in and out of different stocks/products.  As hedge funds grow, they are taking larger positions in certain stocks, and when they decide to sell the stock, are having a hard time unloading the large position in the market.  Conversely, the fund could use the large position to its advantage in hedging its bets or moving the market itself in certain directions.

How does this work?  The market is like any market.  There is a supply and demand for a certain security.  If the seller of that security has a large position, the supply and demand changes between the time the fund wants to sell its first security of that position and last security of that position.  Basically, if the fund has enough shares, it can change the supply and demand of the security it is buying and/or selling.

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