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What is a Hedge Fund ?
When the stock market results are
poor, usage of the term hedge funds tends to increase. Although
hedge funds are not mutual funds, people often mistake Hedge
funds as mutual funds. The word "hedge" refers defensive
management or insurance against bad times, but the truth is
hedge funds come in hundreds of varieties and often use
authority.
Hedge funds refer to funds that use one or more alternative
investment strategies, including hedging against market decline,
investing in terms of currencies or concerned securities, and
utilizing leverage, derivatives, and arbitrage. In other words,
Hedge funds are the type of funds that uses advanced investment
strategies such as leverage, long, short and derivative
positions in both domestic and international markets with the
goal of making high returns.
In legal terms, hedge funds are most often set up as private
investment partnerships that are open to a limited number of
investors and require a very large initial minimum investment.
Hedge funds require their investors to keep their money in the
fund for a minimum period of at least one year. The large
minimum investment required is about $1 Million. The numbers of
Investors are limited and they are referred as limited partners.
A maximum of 499 investors can invest in any one fund. The
person investing should be an accredited investor i.e., the net
worth of the investment should be $1 Million or the individual
income should exceed $200,000 or joint income should exceed
$300,000. The liquidity varies from monthly to yearly basis.
Hedge funds typically charge high fees usually in the range of
1-2% of our assets plus about 20% of the profits.
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The primary objective of the hedge
funds is to reduce instability and risk while trying to save
capital and expecting to deliver good returns under all market
conditions.
There are approximately 14 distinct investment strategies used
by hedge funds. Each investment strategy offers different
degrees of risk and return. Some examples are:
A macro hedge fund invests in stock and bond markets and other
investment prospects, such as currencies. A macro hedge fund is
unstable but possibly grows faster than a distressed-securities
hedge fund that buys the equity or debt of companies about to
enter or exit financial pain.
An equity hedge fund may be global or country specific, hedging
against decline in equity markets by shorting overrated stocks
or stock indexes. |
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A relative value hedge fund takes
advantage of price or spread inefficiencies in the market.
It is necessary to understand the characteristics of the many
different hedge fund strategies to capitalize in their variety
of investment opportunities. All the investment strategies are
not the same since some factors like investment returns;
volatility and risk vary with different hedge fund strategies.
Some investment strategies, which are not correlated to equity
markets, are able to deliver consistent returns with
exceptionally low risk of loss. A successful fund of funds
recognizes these differences and combines various strategies and
asset modules together to create more stable long-term
investment returns than any of the individual funds. It is
necessary to understand the characteristics of the many
different hedge fund strategies to capitalize in their variety
of investment opportunities. All the investment strategies are
not the same since some factors like investment returns;
volatility and risk vary with different hedge fund strategies.
It is necessary to understand the characteristics of the many
different hedge fund strategies to capitalize in their variety
of investment opportunities. All the investment strategies are
not the same since some factors like investment returns;
volatility and risk vary with different hedge fund strategies.
Some investment strategies, which are not correlated to equity
markets, are able to deliver consistent returns with
exceptionally low risk of loss. A successful fund of funds
recognizes these differences and combines various strategies and
asset modules together to create more stable long-term
investment returns than any of the individual funds.
Some of the common points to be
considered
Hedge fund strategies vary enormously against market
downturns, volatility and expectation of alteration in overrated
stock markets.
The primary aim of the hedge funds is to reduce instability
and risk while trying to save capital and expecting to deliver
good returns under all market conditions.
The popular misconception is that all hedge funds are volatile
that they all use global macro strategies and place more money
on stocks, currencies, bonds, commodities or gold, while using
lots of leverage. Actually, less than 5% of hedge funds are
global macro funds. Most hedge funds use derivatives only for
hedging or some hedge funds dont use derivatives at all, and
many use no leverage.
Key characteristics of hedge funds
Some of the key characteristics of Hedge funds are as follows
Hedge funds utilize a variety of financial means to reduce
risk, enhance returns and minimize the correlation with equity
and bond markets. Many hedge funds have flexibility in their
investment options.
Hedge funds vary enormously in terms of investment returns,
volatility and risk. In genreal, hedge fund strategies tend to
hedge against market downturns.
Many hedge funds have the ability to deliver non-market
related returns.
Many hedge funds serve the individuals purpose to obtain
consistency of returns and capital preservation rather than
magnitude of returns.
Most hedge funds are managed by experienced, disciplines and
diligent investment professionals.
Pension funds, endowments, insurance companies, private banks
and high net worth individuals and families invest in hedge
funds to minimize overall volatility and enhance returns.
Most hedge fund managers trade only within their area of
expertise and competitive advantage. The hedge fund managers are
highly specialized.
Hedge funds benefit by providing attractive remuneration and
performance incentives for hedge fund managers, thus attracting
the best brains in the investment business. In addition, hedge
fund managers usually have their own money invested in their
fund.
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Facts
about the Hedge Fund Industry
Hedge fund Industry is growing at about 20% per year and
estimated to be a $1 trillion industry with approximately 8350
active hedge funds.
Hedge fund industry includes a variety of investment
strategies, some of which use leverage and derivatives while
others use some conservative methods and employ very lower or no
leverage. Many hedge fund strategies are found to reduce market
risk specifically by shorting equities or through the use of
derivatives.
Most hedge funds are highly specific, depending on the
specific expertise of the manager or management team.
In Hedge fund industry, Performance of many hedge fund
strategies, especially relative value strategies, is not
dependent on the direction of the bond or equity markets, unlike
conventional equity or mutual funds, which are generally 100%
exposed to market risk.
Some of the hedge fund strategies like arbitrage strategies
are limited to the capital they can successfully spend before
returns weakens. As a result of this limitation, many successful
hedge fund managers limit the amount of capital they will
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Hedge Fund industry employs
generally highly professional, disciplined and diligent Hedge
fund managers.
Hedge Fund Industrys returns over a prolonged period of time
have better standard equity and bond indexes less risk of loss
than equities and with less volatility.
There are some outstanding performers (Hedge fund managers)
apart from averages.
Investment in hedge funds is likely to be preferred by more
classy investors, including many Swiss and other private banks
that have experienced the consequences of major stock market
alteration.
Hedge funds receive assets through increasing number of
endowments and pension fun.
Hedging strategies
There are several hedging strategies available for hedge funds.
For example:
Selling short - This hedging strategy involves selling shares
without owning them, with a hope to buy the shares back in
future at a lesser price with an expectation that their prices
will come down.
Using arbitrage - Seeking to develop pricing inefficiencies
between related securities. For example, pricing inefficiencies
can be long convertible bonds and short the underlying issuers
equity.
Trading options or derivatives This hedging strategy
involves in trading options based on the performance of any
fundamental financial asset, index or other investment.
investing in anticipation of a specific event - merger
transaction, aggressive takeover, spin-off, coming out of
bankruptcy proceedings etc.
Investing in deeply discounted securities This type of
hedging strategy is for companies that are about to enter or
exit financial distress or bankruptcy.
Benefits of hedge funds
Many hedge fund strategies have the capacity to make positive
returns in both rising and falling equity and bond markets.
Inclusion of hedge funds in a balanced group reduces overall
risk and volatility and increases returns.
The investors are offered with many varieties of hedge fund
investment styles, provided many hedge fund investment styles
are uncorrelated with each other to meet their investment
objectives.
According to Academic research, hedge funds have higher
returns and lower overall risk than traditional investment
funds.
Hedge funds provide a correct idea to enter into the market or
to exit from the market. Hedge funds are ideal long-term
investment solution.
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Article Contributed By: Priya Ameet
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