The Social Utility Of Hedge Funds

There is an article inwards the New Yorker magazine profiling Bridgewater Associates, the world's biggest global macro hedge fund. Inevitably, nosotros come upwards to the awkward question: "If hedge-fund managers are playing a zero-sum game, what is their social utility?"


I idea virtually this query a lot inwards the past, and I used to handgrip amongst many others that the social utility of hedge funds, or trading inwards general, is to supply liquidity to the markets. And a expert economical representative tin hold upwards made that the to a greater extent than liquid a marketplace is, the higher the utility it is to all participants. However, based on recent experience of flash crash together with other unfortunate mishaps, nosotros uncovering out that traders typically create not supply liquidity when it is needed most! So this response becomes quite unsatisfactory.


In trying to come upwards up amongst a meliorate reply, I though it is curious that few people asked "What is the role of having a Department of Defence?" since wars betwixt nations are typically also zero-sum games, soundless nosotros greatly accolade those who serve inwards the military machine (in contrast to our feelings for hedge fund managers).


To me, clearly the response amongst the best moral justification is that, inwards both cases, at that spot is dandy social utility inwards defending either your clients' comfortable retirement from fiscal meltdown (e.g. due to governmental or corporate mismanagement), or inwards defending your province from unusual aggression. More specifically, the role of hedge funds is to trim back long-term volatility in your clients' cyberspace worth. (I would similar to tell "reduce risks to your clients' cyberspace worth", but that would hold upwards a chip also optimistic!) 


I emphasize long-term volatility, because of course of study trading generates a lot of daily or hourly volatility inwards your clients' equity. But I create non believe that such short-term volatility affects ones' life goals. On the other hand, a 3-or-more-year drawdown inwards a typical buy-and-hold portfolio tin wreck havoc amongst many lives.

If ane day, the markets expire hence quiescent that few hedge funds tin generate higher Sharpe ratio than a buy-and-hold portfolio (as indeed seems to hold upwards the representative amongst the USA equities markets these days), together with hence yes, most hedge fund managers should simply quit, instead of hogging intellectual resources from our best universities.