Hedge funds are known as the kind of funds that are contributed by a limited number of partners, which in other words known as investors. The investment pool is usually operated by a professional manager whose major and specific goals would be to maximize returns and minimize risk. They are usually distinguished from the other kinds of funds as they are only accessible to accredited or qualified (Wealthy) investors. Moreover, they require lesser regulations than all other forms of investment funds, e.g., Mutual funds. Hedge funds invest in a wide range of commodities such as bonds, stocks, commodities, or even sometimes currencies, and real estate, etc.
History of Hedge Funds
Hedge funds are known to be created initially by a man named “Alfred Winslow Jones," who employed an investment strategy. The purpose of this strategy was to make an investment pool that could balance long equity positions with short positions, to generate high returns and minimize risks. This strategy of a balanced approach is the actual source of the development of hedge fund investing.
How Does It Work?
The basic organization of the hedge fund revolves around an investment fund of a partnership pool in which a fund manager invests the money into different assets to achieve the desired goals of generating large revenues and minimizing risks. Hedge funds usually work due to the smart intelligence and management strategies of the fund managers who try to convince the qualified and eligible investors to invest in a certain pool of investment. Then invest this money in many assets such as different kinds of stocks, bonds, mutual funds, currency, or in real estate, whatever according to him, is profitable and expected to increase their capital.
How Does It Differ From Mutual Funds?
Although hedge funds and Mutual funds usually seem to be similar, as they might have the same basic structure, however, some key differences distinguish them from Mutual funds.
- The first difference is that the hedge funds require accredited and qualified investors, while mutual funds usually do not employ “Only Accredited” investors.
- Moreover, the mutual funds have fluidity as their assets are usually bought and sold quickly without affecting the market value instead of hedge funds. These funds have long equities and redemptions in long terms only, and their goal is to promote market value neutrality.
- The third difference is that the hedge funds usually invest in a wide range of investments than mutual funds, such as stocks, bonds commodities, real estate, currency, and food industries, which can make them riskier than mutual funds.
- Fourthly, the hedge funds can make money even when the market is bad because of their ability to sell stocks shortly because of their understanding of expected gains and positions of the market. However, among mutual funds, this might not be the actual scenario as they are significantly affected when the market conditions are worsening.
- Lastly, the fund managers who successfully manage the hedge fund investing usually get a significant and large amount of profits as they get 20% of the fund's profit, however, managers of mutual funds are mostly liable of a small percentage of the assets.
How To Qualify For Hedge Fund Investing
For qualifying for hedge fund investing, the distinct requirement is to be an accredited or well-off (Wealthy) investors who can invest a certain amount of capital and do not require short returns. For instance, To qualify for hedge fund investing, you need to have either
- An annual income of at least $200,000 or more, and if you have combined income with your spouse, then at least $300,000 or more.
- The personal Net worth of $1 million (alone or combined with a spouse)
- Or you might have an employee benefit plan, which can be around $5 million.
It is also important to note that there are certain regulations by Government for Hedge fund managers that if they desire to employ few non-accredited investors in the investment pool. Then they must be trustable or guaranteed by the fund manager himself (such as friends or family members). The capacity is equal to or less than 35 members only in some cases.
Please none of this is legal advice, please speak to an attorney about your specific requirements.
Types of Hedge funds
As we have understood that hedge funds are the ones whose main goal is to generate maximum profits while minimizing the risks; however, there are several kinds of strategies through which hedge funds perform. These types of hedge funds have different goals; therefore, they work accordingly to achieve the goal of investments.
- Macro Hedge funds
Macro hedge funds are the type of hedge funds that invest in bonds, stocks, futures, and currencies to gain maximum return due to the market changes and variations in the macroeconomic variables such as interest rates, global trade, or policies. Due to their specifications, they are extremely diversified and highly leveraged.
- Equity Hedge funds
The second kind of Hedge funds is known as Equity hedge funds, which are also sometimes termed as Long/short equity or hedge funds, attempts for hedging against the declines, or fall in the market situations. They usually perform it by investing in various stock indices as well as stocks for shorting them later (if they are later observed to be over-valued).
Benefits Of Investing In Hedge Funds
Hedge funds have significant benefits over the other kinds of funds, which make them unique and attractive. They are usually known to offer more financial incentives and profits to their managers because of their expertise and speculations in investments. Along with the lack of financial regulation needed to regulate them. More specifically, they have the following benefits or rewards:
- Hedge fund managers are usually paid more based on the returns they receive, and due to their convincing nature and expertise in speculations, they achieve a higher return than the market.
- These fund managers can achieve a wealthy and hefty amount in return if they correctly predict the rise and fall of the market. Hedge fund managers are good at using complex derivatives to create profits and leverage, even when the stocks market fall.
- Lastly, as hedge funds are less regulated than the stock market; therefore, managers of hedge funds usually have greater flexibility when investing in speculative financial instruments and convince the investors to bring higher returns.
Significant Risks Associated With Hedge Fund Investing
There are significant risks, which are associated with the hedge fund investing because of the nature and diversities of the assets in which the fund manager invests. Therefore the fund manager is expected to evaluate the potential risks concerning the rewards which relate to the investment.
Hedge funds are usually associated with three types of greater risks, which are the following:
- As the funds related to hedge funds are not regulated primarily with the US Securities and Exchange Commission's (SEC) registration and regulations as it gets invested in private hedge funds. Therefore, the lack of regulatory control and supervision might create a significant risk for investing in hedge funds.
- The hedge fund investing is usually dependent on speculative skills and expertise of funds managers who invest in diversified assets; therefore, it is liable to be an aggressive and risky kind of investment. Moreover, as the hedge funds are known to be illiquid investments, hence it is usually not possible for investors to take out their invested money at their desire or requirement.
Therefore the investors are expected to be informed about the above risks as well as ensuring that they are financially sound and accredited before they decide to invest in hedge funds.
Hedge fund investing is a significant kind of investing than other investment firms, as they generate higher returns and enable lesser regulations than mutual funds. However, due to the risks associated with the hedge funds, the investors should be in an accredited or wealthier position before they decide to invest in the hedge funds.
About the Author,
Alexa Bliss is a blogger and academic writer at "Nursing Assignment Help." She has done Masters in Sociology along with a diploma in Digital Marketing. She loves writing about different topics, including health and fitness. Her hobbies include travelling, playing basketball, and listening to soft music.