capital flow to the sector has meant, not unexpectedly, that profitability has declined and it is not unreasonable to expect that a number of funds will consequently be forced to close down after more or less substantial losses. however, the advantages of the hedge funds ’ operations exceed the risks from a welfare perspective. the riksbank ’ s view as regards further regulation is that the focus should be on the hedge funds'counterparties - particularly the systemically - important banks - being able to manage their risks. improving the banks ’ risk management with regard to hedge funds has been the objective of a number of initiatives by the basel committee on banking supervision and other organisations ever since the ltcm crisis in 1998. from a stability point of view, the central issue is that the systemically - important banks should manage their counterparty exposures correctly – take sufficient collateral, have appropriate limits and be capable of managing potential liquidity problems. the arguments for further regulation of hedge funds are in this context weak.

shares should rise relatively more on a rising market and the price of over - valued shares should fall relatively more on a falling market. if the fund managers made a reasonable selection, this meant that the fund would earn money regardless of whether the market rose or fell – in other words the fund was protected, or hedged, against systematic market risk. in other words, the initial idea of hedge funds was to take positions based on the price relationships between securities, while limiting or eliminating market risk. many people still connect the concept of a hedge fund with this strategy, but today this so - called market - neutral strategy is only one of many. moreover, the concept hedge fund is misleading, as many of the funds do not hedge, but take large net positions. a common factor for hedge funds is that they have absolute earnings targets - rather than relating earnings to a benchmark index. they are also subject to much fewer restrictions concerning investment strategies than traditional funds. in addition to buying securities, the hedge funds can go short, that is to say, they can sell securities they do not own. moreover, they can use pledges or derivatives to increase or decrease the risk in their fund management. investments in hedge funds are often tied over a long period of time, which means that the fund can take on fairly illiquid positions. the charges are performance - based, which gives the fund managers a clear incentive to strive for good earnings. it is also common that fund managers themselves invest substantial amounts in their own hedge fund. for a more detailed review of hedge funds, see the article in the riksbank ’ s financial stability report 2006 : 1. however, hedge funds are far from a homogeneous group. one may roughly distinguish three overall investment strategies : market - neutral, directional and event - driven. market - neutral strategies attempt, as i mentioned earlier, to exploit differences in the valuation of various securities, while trying to protect themselves against overall market risk. directional strategies entail finding macroeconomic trends and trying to predict future market movements. event - driven strategies aim to identify securities whose prices will be affected by specific corporate events, such as acquisitions, mergers and bankruptcies. neither of the latter two investment strategies is thus hedged in jones ’ original sense. many hedge funds describe themselves as " multi - strategy ” – they combine different strategies over time to achieve the highest possible earnings. this also applied to amaranth, but the fact was that half of the fund ’ s assets were invested in forward