Hedge funds: the shadow players making and breaking markets

They manage trillions of dollars and dictate the pace of trading sessions. Yet most retail investors know them only by their generic name.

When the S&P 500 rallies 3% in a single session, as it did in late March, the media points to geopolitics. When it drops 5% over three weeks, uncertainty is mentioned. This is rarely false, although it is always incomplete. Behind every major move lie decisions made by players whose very inner workings are often unknown to the general public.

This article is the first installment in a series dedicated to these players. The aim is to understand what hedge funds are, how they operate, and why their decisions ripple through the markets.

But what exactly is a hedge fund?

In 1949, Alfred Winslow Jones, a former Fortune journalist turned financier, created the first "hedged fund." His idea: buy promising stocks while short-selling the weakest ones to generate returns regardless of market direction. The term "hedge fund" was born from this hedging logic.

Today, a hedge fund is a private investment vehicle reserved for sophisticated investors, free to short-sell, use leverage, intervene across all markets, and concentrate its bets. In Europe, these vehicles are classified as Alternative Investment Funds (AIFs), governed by the AIFM directive. They are more flexible than UCITS, yet regulated. The entry ticket ranges from a few hundred thousand to several million dollars. Clients include pension funds, foundations, family offices, and funds of funds.

Most are domiciled in jurisdictions with favorable tax and regulatory frameworks (Cayman Islands, Delaware, Luxembourg). Managers charge high fees, a legacy of the "2 and 20" model: 2% management fee, 20% performance fee. According to With Intelligence, the median has slipped toward 1.25-1.50% and 15%-19%. Investors are protected by the high-water mark (no commission until the fund exceeds its previous peak) and the hurdle rate (a minimum return threshold before fees are collected). Lock-up periods range from a few months to several years.

According to Barclays, the industry surpassed 5 trillion dollars in assets under management in 2025, driven by the highest inflows in nearly two decades. Compared to the 267 trillion dollars in investable assets worldwide according to Ocorian, the figure seems modest. This is misleading: leverage multiplies the actual footprint of hedge funds. In 2025, they posted an average return of 11.8% and attracted $79bn in net inflows according to Goldman Sachs. Nearly 49% of allocators stated that they intended to increase their exposure in 2026, a record. Volatility amplified by the conflict in Iran is creating the conditions where stock selection makes all the difference.

How do these funds invest their trillions?

Key strategies

Hedge funds are divided into several major families. Some bet on equities, others on macro trends, others on specific events.

Long/short equity funds, the most common, buy stocks deemed undervalued and short those that appear overpriced. Most maintain an upward exposure (net long bias) and suffer when the market declines. Last month served as a reminder: -3.96% on average according to Goldman Sachs Prime, with TMT (Tech/Media/Telecom) strategies leading the decline at -7.8%.

Macro funds play macroeconomic trends (rates, currencies, commodities) via futures and options. CTAs (Commodity Trading Advisors) invest via algorithmic "trend-following" strategies: they buy what is rising and sell what is falling. This management can amplify trends but also creates exhaustion points when positioning reaches an extreme.

Multi-strategy funds allocate capital across different teams called "pods," with each pod operating as an autonomous mini-fund. Goldman Sachs noted that March 7 and 10 constituted "one of the worst performance episodes in years," dubbed "multistrat-mageddon." Event-driven funds exploit specific situations (mergers, restructurings, activism), and arbitrage funds capture price discrepancies between related assets.

But why do their decisions impact the markets you follow daily?

What is the market impact?

In mid-March, the average gross leverage of hedge funds tracked by Goldman Sachs hovered around 307%, near a record high, according to John Flood as reported by Bloomberg. For every $100 of capital, $307 are committed. At the end of January, the "Magnificent 7" accounted for 19% of net exposure to US equities according to Goldman Sachs. When everyone holds the same positions, the exit door becomes too narrow: managers sell what they can, not what they want. This is why unrelated stocks fall simultaneously during periods of stress.

The domino effect amplifies everything. Hedge funds borrow from their prime brokers. When a fund suffers losses, its broker demands a margin call, forcing it to sell. These sales trigger new calls for other funds. As a reminder, in 1998, LTCM had accumulated $125bn in positions for $4.7bn in capital according to the New York Fed. The Russian default forced a coordinated bailout among 14 banks. In 2021, according to the FT, Archegos caused more than $10bn in losses for its brokers with the same cocktail: massive leverage, concentrated positions and absent liquidity at the worst possible moment.

Gamma. It is not a hedge fund that causes this effect, but the market makers (dealers) who sell the options that hedge funds buy. To hedge themselves, these dealers constantly adjust their positions. In positive gamma, they pull prices back toward the center. In negative gamma, the opposite occurs: they sell when prices fall and buy when they rise, propelling prices further.

One question remains: a threat or an indispensable gear?

A necessary nuance

Hedge funds are feared. But without them, markets would function less efficiently. They provide liquidity and contribute to price discovery. Beber and Pagano (Journal of Finance, 2013) also showed that short-selling bans in 2008 deteriorated liquidity without preventing declines.

Systemic risk is well-documented. But according to the Financial Stability Board, the answer is not to eliminate these actors. It is to prevent their next accident from becoming everyone's accident.

During the 2010s, hedge funds only annualized about 4% with an alpha of 50 basis points according to Barclays. After fees, investors would have been better off buying an ETF. Buffett won his 2008 bet against Ted Seides based on this observation. But conditions have changed. When correlations drop and performance dispersion between stocks widens, as has been the case since 2020, stock picking becomes profitable again. Barclays estimates the return to over 300 basis points of annualized alpha.

The comparison remains imperfect: many strategies do not seek to beat an index but aim for risk-adjusted returns or decorrelation. Allocators favor hedge funds for their role in a diversified portfolio, not as a substitute for an ETF.

In the next installment, we will step into the engine room of a fund to show how a hedge fund strategy is concretely constructed.