Private equity firms and hedge funds share a couple of key features: both are investment firms that cater to wealthy clients, and both charge hefty fees for their ability to extract profit from publicly traded corporations in order to produce “alpha,” an excess return above a benchmark index. In other words, investors are willing to pay higher fees because they are promised higher returns than can be achieved through safer investment strategies. While a PE firm’s primary strategy is the leveraged buyout of a public firm, a hedge fund uses financial instruments and pressure tactics. The term hedge fund dates back to the 1940s, when it described a trading strategy that “hedged,” or limited, risk by betting against market fluctuations, using instruments such as short selling (betting that an asset will decline in value). The term has since been appropriated by speculators for whom leveraging risk (using borrowed capital to increase potential return), and lots of it, is the dominant strategy. In other words, hedge funds dramatically increase risk, rather than limiting or hedging it.

DEFINE: Defines 'hedge fund' by contrasting its original 1940s meaning (limiting risk through short selling) with its modern practice of leveraging risk.

Andrew deWaard, Derivative Media, loc. 142