Let's see what the Fed's Patrick Peterson who is the Deputy Director of the Division of Research and Statistics had to say to the Subcommittee on Securities and Investment, Committee on Banking, Housing, and Urban Affairs, U.S. Senate
* "In my remarks today, I will discuss the increasing importance of that role, the public policy issues associated with it, and what the Federal Reserve has been doing to address concerns about potential systemic risks from hedge funds’ activities."
*" The role that hedge funds are playing in capital markets cannot be quantified with any precision. A fundamental problem is that the definition of a hedge fund is imprecise, and distinctions between hedge funds and other types of funds are increasingly arbitrary....
Although several databases on hedge funds are compiled by private vendors, they cover only the hedge funds that voluntarily provide data.1 Consequently, the data are not comprehensive. Furthermore, because the funds that choose to report may not be representative of the total population of hedge funds, generalizations based on these databases may be misleading. Data collected by the Securities and Exchange Commission (SEC) from registered advisers to hedge funds are not comprehensive either. The primary purpose of registration is to protect investors by discouraging hedge fund fraud. The SEC does not require an adviser to a hedge fund, regardless of how large it is, to register if the fund does not permit investors to redeem their interests within two years of purchasing them.2 "
* "Even if a fund is included in a private database or its adviser is registered with the SEC, the information available is quite limited. "
* "Although the role of hedge funds in the capital markets cannot be precisely quantified, the growing importance of that role is clear. Total assets under management are usually reported to exceed $1 trillion.4 Furthermore, hedge funds can leverage those assets through borrowing money and through their use of derivatives, short positions, and structured securities. Their market impact is further magnified by the extremely active trading of some hedge funds."
* " Hedge funds and their investment advisers historically were exempt from most provisions of the federal securities laws.8 Those laws effectively allow only institutions and relatively wealthy individuals to invest in hedge funds. Such investors arguably are in a position to protect themselves from the risks associated with hedge funds.9 However, in recent years hedge funds reportedly have been marketed increasingly to a less wealthy clientele. Furthermore, pension funds, many of whose beneficiaries are not wealthy, have increased investments in hedge funds"
It goes on and is very interesting but I have included too much already and will leave the rest to you.
(As an aside to professors, students seem very interested in this discussion and I highly recommend bringing it into the classroom! I do so after discussing the importance of hedge funds and discussing Long Term Capital Management.)