than 15 years, these numbers have increased dramatically. current estimates suggest that approximately 7500 hedge funds manage assets totaling close to usd 1000bn ( graph 1 ). 3 remarkably, according to the csfb / tremont hedge fund index, there have been only a few quarters with net outflows since 1994. 4 these figures demonstrate that the hedge fund industry has matured at an extraordinary rate and today constitutes a non - negligible component of the global asset management industry. 5 a more detailed study on hedge funds will be published in the forthcoming quarterly bulletin of the swiss national bank ( march 2005 ). alfred winslow jones is credited for the creation of the first hedge fund in 1949. his strategy consisted in combining long positions in undervalued stocks and short positions in overvalued stocks, in an attempt to minimise the influence of overall stock market moves. to magnify his portfolio ’ s return, jones added leverage. according to hedge fund research inc., 7436 funds managed usd 973bn of assets at the end of 2004. other sources may come up with different figures. the csfb / tremont hedge fund index is the largest asset - weighted hedge fund index. the csfb / tremont index is broadly diversified, encompassing around 400 funds across ten style - based sectors, and representative of the entire hedge fund industry. assets included within the csfb / tremont hedge fund index amounted to usd 615bn in september 2004. performance is calculated net of fees. not included in these figures are significant pools of capital held in privately managed accounts run by hedge fund managers as well as capital managed by the proprietary desks of global investment banks. though typically not formally structured around hedge fund vehicles, these assets closely mirror the investment activities of hedge funds. until the second half of the nineties, the hedge fund industry capital base was largely one of high net worth fortunes. part of the acceleration of inflows throughout the second half of the nineties can be attributed to pension funds, endowments and other institutional investors who have begun to allocate small percentages of their asset base to hedge funds. more recently, funds of funds have become an important source of new inflows to the industry. the largest share of the industry ’ s total client base continues to be private wealthy individuals either as direct investors or through funds of funds. industry flows data suggest, however, that assets from institutional investors have recently grown more rapidly than the overall industry asset base. a major

##ly, these same financial incentives have encouraged many lesser talents to disguise themselves as hedge fund managers. i suspect, over time, investors will only be willing to pay prevailing hedge fund fees for truly outstanding managers. hedge funds have rendered financial markets more liquid, more efficient and, ultimately, more flexible. nonetheless, market observation suggests that in some specific cases, certain segments of the hedge fund industry may have recently had some impact on market volatility, either by accentuating existing market trends or by causing sharp price reversals or gapping price movements. the use of leverage is a central characteristic of the hedge fund industry. overall industry leverage is extremely difficult to measure. market and survey evidence suggests that it is currently moderate. however, such leverage estimates must be interpreted with great caution. they are unlikely to capture the real extent of leverage embedded in the hedge fund industry. leverage matters in a number of ways. one particular concern is that diminishing hedge fund returns in the aftermath of large capital inflows might motivate hedge fund managers to use extreme leverage to generate returns commensurate with the prevailing hedge fund fee structure. systemic risks could conceivably result from such elevated levels of financial leverage, primarily through large credit risk transfers to the global banking system. ultimately, leverage combined with inept asset management strategies will lead to hedge fund failures. these are likely to occur in the future as they have in the past. it is not inconceivable that expansionary monetary policy and the resulting global liquidity boost provide fertile grounds for the rise and fall of hedge funds. in the event of hedge fund failures, investors – for the most part wealthy individuals – will lose money. in some cases, these amounts could be vast. nonetheless, such losses have no bearing on the stability of the financial system and should be of no concern to policy makers. what financial and economic policy makers must be concerned with are hedge fund failures or hedge fund activities that undermine the stability of the global financial system. prudent and disciplined risk management methods, operations and processes in the global investment banks provide the most reliable defense against an erosion of lending standards and the potentially hazardous consequences of the use of excessive leverage in the hedge fund industry. graph 1 aum in usd bn number of funds number of hedge funds and assets under management 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 no. of hedge funds assets under management source : hfri graph 2 all hedge fund assets flows and