investing in, hedge funds. II Capacity constraints. Hedge funds with excellent performance and robust investment processes may find the demand by investors to be greater than the estimated capacity of the strategy. Since most of the revenue for a successful hedge fund comes from performance fees rather than the fixed management fee, many managers reach the point where it is in their best interest to turn away new investment. In fact, extremely successful hedge funds may even return capital to investors, preferring to maintain the ability to generate excellent returns on a smaller capital base to having more assets under management. The fact that some managers close their funds means that the investable universe of hedge funds is a subset of the whole. The resulting inability to invest in many hedge funds implies that the returns of indexes attempting to measure the performance of the hedge fund universe may not be attainable, even for large institutional investors. Notably, none of these characteristics mentioned addresses the issue of what investment strategies are associated with hedge funds. Figure 27.2 briefly summarizes some broad hedge fund strategies, stratified along four sectors. This is not an exhaustive list of hedge fund strategies, nor is it a definitive classification system. It does, however, provide a structure within which to analyze hedge funds. DEFINING THE INVESTMENT UNIVERSE Investors contemplating an allocation to hedge funds are first faced with the fact that there is no single, exhaustive listing of hedge funds, and that the universe is large and continually changing as hedge funds go in and out of business. TASS Research speculates that a conservative estimate of assets under management in hedge funds is between $500 million and $600 million, and an often-quoted statistic suggests there are over 6,000 hedge funds in existence. Probably there are about half this number of strategies, with multiple share classes. Since no single listing of managers exists, the investor must create the investment universe using a combination of commercially available databases and ad hoc information gathering. Commercial providers of hedge fund data rely on managers to report their data and styles, resulting in a number of biases to the databases (see Chapter 26 for further discussion). As well, most managers who are closed to new investment do not report their returns to the databases. To better understand the magnitude of this problem, consider two commercially available databases-Hedgefund.net and TASS. Each has an equity long/ short category. Hedge funds in this category invest long and short in equities, with the goal of delivering excellent risk-adjusted returns. After adjusting for multiple share classes and misclassified managers, there are 684 funds in Hedgefund.net's long/short equity category and 677 funds in the TASS long/short equity category. Overlap between the two databases is 249 funds, so clearly neither database is comprehensive. A further complication of defining the investment universe is determining exactly what falls within the category of "hedge fund." Notably, the definition of