In an exclusive interview on cnbc.com, Treasury Secretary Henry Paulson said hedge funds have had a positive impact on capital markets but need to be more closely monitored in an effort to protect investors.
"This is something we are giving a lot of thought and attention to," Paulson told CNBC's Maria Bartiromo. "There have been major changes in the capital markets over the past five to ten years, including big increases in private pools of capital."
Hedge funds are private investment partnerships for wealthy and institutional investors. Lightly regulated, hedge funds invest in ways not available to more traditional mutual funds, such as selling short and taking certain arbitrage and derivative positions.
Hedge funds have come under greater scrutiny as assets ballooned. There are now more than 9,000 hedge funds, which have doubled their assets over the past five years to $1.3 trillion. That’s also up from nearly $39 billion in 1990, according to Hedge Fund Research.
Paulson said they are examining hedge funds in three areas, including: investor protection; systemic risk, or ensuring that there is enough liquidity in the system; and transparency between the hedge funds and those lending them money.
"By and large, hedge funds (and derivatives) have been positive for the capital markets" Paulson said. "They have made them more efficient, more liquid" and have helped disperse risk.
The Securities and Exchange Commission adopted a rule in 2004 ordering most hedge fund advisers to register with the investor protection agency. But a federal court threw out the rule in June.
Since the SEC's registration rule was struck down, the agency has been developing scaled-back rule proposals, including one to raise the minimum net worth an investor must possess to be allowed to invest in hedge funds. That proposal is expected to come before the SEC for a vote next week.
The average annualized performance of hedge funds 14.03%, according to the HFRI Fund Weighted Composite Index. The typical hedge fund charges investors a 2% management fee, along with a 20% share of profits.
The SEC is probing whether there is any impropriety going on between the transfer of information between Congress and hedge funds, according to Friday's Wall Street Journal. Hedge funds are increasingly hiring lobbyists not to influence government, but to tell them what it’s going to do, the paper said. It’s not illegal for lawmakers to disclose information that isn’t public, but the SEC is trying to resolve whether the transfer of information by lobbyists and others to investors violates investor trading law.