What is a hedge fund? And what are its advantages? And his type?


In financial vocabulary, “hedge” means to hedge, to spread risk. But contrary to this definition, not all hedge funds aim to neutralize one or more sources of risk. This is the main advantage of hedge funds and is therefore often very risky.

What is a hedge fund?

Hedge funds are alternative investments using pooled funds that use various strategies to earn active returns for their investors. Hedge funds may be aggressively managed or used derivatives and financial leverage in both the local and international markets with the aim of achieving high returns (either in an absolute sense or based on a specific market standard).

It is important to note that hedge funds are generally only available to accredited investors as they require authority regulations Money bills And stock exchanges are lower than other funds. One aspect that has characterized the hedge fund industry is the fact that hedge funds face less regulation mutual funds and tools investment other.

Today the term “hedge fund” includes a variety of funds using non-traditional management techniques.

Although there is no legal definition for these funds, they can be described as funds that aim to achieve absolute performance. The approach used to achieve this absolute return uses the same assets Like traditional managers but based on different strategies, more aggressive and riskier.

Hedge funds are flexible financial instruments, able to position themselves in all classes of financial instruments, whether to buy or sell, in any market and with very large leverage effects (several times the size of the fund).

One of the principles of hedge funds is the manager’s remuneration, which is closely related to the results. This partly explains this quest for sheer performance. Thus, the industry attracts the best “brains” in the field.

How does a hedge fund work?

The hedge fund manager collects money from outside investors and invests that money according to whatever strategy they promised to use. There are hedge funds:

  • Specialize in “only long” stocks, which means they buy only common stock and never short
  • Engage in private equity, which is buying, often taking over, wholly privately owned companies, improving operations, and later sponsoring an initial public offering
  • Junk bond trading
  • They specialize in real estate
  • Invest money in specialized asset classes such as patents or music rights.

The main strategies of hedge funds

Hedge fund managers use a variety of strategies. These different strategies are categorized according to the tools used and the investment approach.

trend strategies

This category includes managers of the long/short type whose investment consists of betting on the direction of the market and hedging themselves with positions in the opposite direction (buy/sell).

Another type of position is the dedicated short bias, which consists of “shorting” a bear market. There are also typical market neutral strategies that focus on completely eliminating market risk.

Distressed stock strategies

Specialists in this investment style intervene in stock companies that are in difficulty, experiencing operational problems, significant management team changes, or legal liability issues. Managers only intervene in the securities of companies with a low credit rating (CCC).

Derivative Strategies

Of course, derivative products such as futures, options, or bond Convertible preferred instruments can provide substantial returns.

This category includes a commodity trading advisor which is futures and futures funds. Managers of this type of fund look for trends in the market and take positions through futures and forward contracts (commodities, prices, currencies, etc.).

Convertible bond management constitutes a complete strategy using various financial instruments. The principle is to take advantage of the price relationships between a bond and its underlying asset.

Global macromanagement consists of exploiting various economic and financial turbulences around the world by playing on all financial instruments (rates, currencies, andStock futures contracts, etc.).

hedge fund requirements

You must meet certain income and net worth requirements to invest in a hedge fund. Generally, only “accredited investors” are able to invest in these funds due to government regulations. Accredited investors can be either a person or an entity

Hedge funds are not subject to some of the federal rules that protect ordinary investors, and this can make them riskier than other investment options.

Individual investors must meet one of these criteria:

  • They must have a personal income of $200,000 or more annually. It is necessary that the combined income of the spouses be $300,000 or more annually if the investor is married. This level of income must be maintained for at least two consecutive years and the investor must have reason to believe that he will maintain this level of income in the future.
  • It is necessary that their personal net worth be $1 million or more, either alone or with a spouse, excluding their primary residence.

If the investor is an entity:

  • It can be a trust with a net worth of $5 million or more, that was not specifically formed for the purposes of making the investment, and must be managed by a “sophisticated” investor.
  • Any entity in which all equity investors are accredited investors can be on their own merit
  • The Securities and Exchange Commission describes an experienced investor as someone with sufficient investment knowledge and experience to make informed decisions about the risks of a potential investment.

Hedge fund fees and charges

Hedge fund managers are compensated based on the terms or arrangements in their fund operating agreements, but many hedge fund managers receive the “2 and 20” standard. They receive 2% of net assets annually, plus 20% of profits above a predetermined hurdle. Other hedge fund managers are paid on a pure profit arrangement.

Comparison of hedge funds and mutual funds

The two biggest differences between hedge funds and mutual funds are:

  1. Who can invest in the fund
  2. How to collect fees.

Although both funds tend to invest largely in stocks of public companies, they raise money from different sources.

Mutual funds can raise capital from anyone in the general public, while hedge funds are limited to institutional investors and limited partners.

Since mutual funds follow the Investment Act of 1940, they are only allowed to charge management fees. Hedge funds, which do not follow the law, charge management fees as well as investor performance fees.

Comparison of hedge funds and private equity funds

Hedge funds and private equity (PE) funds are considered alternative assets and are restricted to qualified and institutional investors. The two biggest differences between a hedge fund and a private equity fund are the structure of the fund and the types of companies they invest in.

Hedge funds are open-end funds, while private equity funds are closed-end. As the name suggests, open-end funds do not have to close, allowing investors to contribute to or withdraw their money from the fund at any time.

In closed-end funds, the fund will be closed and the capital raised will be invested in long-term investments, where the money will be tied up until it is released by the fund manager, which can easily be a decade after the time it was invested for the first time.

The difference in fund structure is largely due to the types of companies they invest in; Hedge funds are mostly public market investments, while private equity funds invest in private markets.

What are some criticisms of hedge funds?

Even though hedge funds are open-ended funds, the fund manager may not always accept new subscriptions – which can limit entry for investors in a well-functioning hedge fund.

Fund managers can also temporarily block investors from receiving redemptions regardless of when they subscribe. This move is called “gates” and was used during the 2008-2009 global financial crisis, when a market downturn shrank their investment portfolios, and LP redemptions may have cut the entire fund.

Conclusion

  • A hedge fund is often a limited partnership or limited liability company that collects money from investors to invest in securities and other high-risk options.
  • These funds are restricted to wealthier investors due to their higher fees and the investment risks involved.
  • Hedge funds can specialize in investing in businesses, junk bonds, real estate, or even patents and music rights.
  • Hedge funds are restricted to “accredited investors” who must meet strict financial requirements.

common questions

What is a hedge fund?

Hedge funds were originally structured to hold both long and short stocks. So positions were “hedged” to reduce risk, and thus investors made money regardless of whether the market went up or down. The name stuck and the term was expanded to include all types of pooled capital arrangements.

What exactly does a hedge fund do?

A hedge fund is a group of funds contributed by investors and managed by a fund manager whose objective is to maximize returns and eliminate risk. Regardless of the structure, a hedge fund is run by a manager who invests money in various assets to achieve the goals of the fund.

Why are hedge funds bad?

Hedge funds also increase the risk. Their use of leverage allows them to control more securities than if they were buying long. They used sophisticated derivatives to borrow money to make investments. This results in higher returns in a good market and larger losses in a bad market.

How do hedge funds make money?

A hedge fund makes money by charging management fees and performance fees. While this fee varies by fund, it usually manages between 2% and 20% of AUM. This incentive fee pushes the fund to generate excess returns. …





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