Hedge Funds
Table of Contents
Hedge Funds
Hedge fund investments may be a smart strategy to diversify your portfolio and shield against market volatility if you meet the criteria for accredited investors and are prepared to make one-time investments of US$100,000 or more. Yet for the typical investor looking for large returns, investing in index funds that follow significant benchmarks like the S&P 500 is probably a better choice.
What is a hedge fund?
Hedge funds are private investment partnerships typically only open to accredited investors. Hedge funds use a variety of strategies to generate returns, including long/short equity, global macro, event-driven, and relative value. Hedge funds typically charge performance and management fees deducted from the fund’s assets.
Understanding a hedge fund
Hedge funds are investment vehicles that typically use high-risk, high-return strategies to generate absolute returns (meaning returns that are not linked to the performance of a benchmark index).
These strategies can include short-selling, leverage, and derivatives trading. While hedge funds can offer potential rewards, they also come with high risk. Investors in hedge funds should be aware of the potential for losses and the limited transparency and regulatory oversight of these types of investments.
They do resemble mutual funds or exchange-traded funds (ETFs), but unlike mutual funds, hedge funds don’t have restrictions. They are more likely to use risky investment techniques, including leverage, debt-based investing, and short sales, and they have access to assets that other funds cannot, such as real estate, fine art, and currencies.
Types of hedge funds
- Global macro hedge funds
They are actively maintained funds that look to profit from significant market movements brought on by political or economic events. They don’t take positions in any individual corporations or even industries. They have a macro perspective of the financial world and anticipate those moves.
- Equity hedge fund
A global or country-specific equity hedge fund may invest in profitable stocks while protecting itself against equity market declines by selling short overpriced equities or stock indexes.
- Relative value hedge fund
Hedge funds are generally relative value funds, which frequently try to employ leverage to increase their returns. These funds will employ margin trading to buy assets they believe are cheap and sell comparable securities they believe are overpriced.
These funds aim to profit from short-term price variations between related assets by taking advantage of spread or pricing inefficiencies.
- Activist hedge fund
These funds invest in firms to increase the stock price by demanding that expenses be reduced, assets are reorganised, or the board of directors be replaced.
What are the different strategies of hedge fund investing?
Hedge funds use a variety of investment strategies to generate returns, including long/short equity, event-driven, and global macro.
Long/short equity hedge funds
They take long and short stock positions to profit from rising and falling stock prices.
- Event-driven hedge funds
They focus on special situations, such as mergers & acquisitions, spin-offs, and bankruptcies.
- Global macro hedge funds
They take positions in various asset classes, including stocks, bonds, currencies, and commodities, to profit from global macroeconomic trends.
- Fixed-income hedge fund strategy
This strategy seeks capital preservation while providing investors with stable returns with little monthly volatility by holding short and long positions in fixed-income assets.
Who should invest in hedge funds?
The U.S. Securities and Exchange Commission (SEC) imposes restrictions on who can participate in hedge funds due to the greater levels of risk involved.
An accredited investor or an institutional investor, such as a pension fund, must be present for an individual to participate in a hedge fund. A net wealth of at least US$1 million, excluding the value of their principal property, or an annual individual income of over US$200,000 (US$300,000 if you’re married), qualifies as an accredited investor.
Frequently Asked Questions
Hedge mutual funds are taxed at the same rate as other mutual funds. However, because they often use complex investment strategies, they may be subject to additional taxes. For example, if a hedge fund invests in derivatives, it may be subject to the “kiddie tax” on investment income.
LPs or limited liability corporations (LLCs) are the most popular organisational forms for hedge funds. While LPs and LLCs are taxed by default as partnerships, they are both pass-through entities for taxation.
Hedge funds use a different risk-return goal than conventional investments like equities, bonds, and mutual funds. Most hedge fund investors anticipate significant returns to make up for the associated risks they are exposed to.
In contrast to hedge funds, which are private investments available to approved investors only, mutual funds are controlled investment products made available to the general public and open for daily trading. Hedge funds are renowned for employing higher-risk investment techniques to provide their investors with greater profits.
There are a few things to keep in mind before investing in hedge funds.
- First, it is important to understand the difference between hedge funds and other types of investments. Hedge funds are typically more volatile and risky than traditional investments, so it is important to understand your risk tolerance before investing.
- Second, doing your research and due diligence before investing in any hedge fund is important. There are many different types of hedge funds, and choosing one that aligns with your investment goals is important.
- Finally, it is important to remember that hedge funds are not for everyone. If you are uncomfortable with the risks, avoiding investing in hedge funds may be best.
Hedge funds generate money through a fee structure depending on the assets under management (AUM) paid by fund investors. In addition to a flat fee, funds frequently earn a percentage of gains beyond benchmark or predetermined rate limits.
Hedge funds’ high level of leverage allows them to provide exceptionally huge returns. However, hedge funds are only suited for a few prestigious organisations or wealthy individuals to participate because of their low transparency, complicated investing techniques, and minimal information sharing.
Related Terms
- Enhanced Index Fund
- No-Load Fund
- Back-End Load Funds
- Appreciation Funds
- International Value Funds
- Small-Cap Value Funds
- Debt Funds
- Pension Funds
- Broad Market Index Funds
- Mid-cap value funds
- Large Cap Value Funds
- Sector Specific Value Funds
- Ultra-Short Bond Funds
- Sub-Advised Fund
- Provident Fund
- Enhanced Index Fund
- No-Load Fund
- Back-End Load Funds
- Appreciation Funds
- International Value Funds
- Small-Cap Value Funds
- Debt Funds
- Pension Funds
- Broad Market Index Funds
- Mid-cap value funds
- Large Cap Value Funds
- Sector Specific Value Funds
- Ultra-Short Bond Funds
- Sub-Advised Fund
- Provident Fund
- Sovereign Wealth Funds
- Management Fees
- Clone Funds
- Net asset value per unit
- Closed-End Funds
- Fixed Maturity Plans
- Prime Money Market Fund
- Tax-Exempt Money Market Fund
- Value Fund
- Load Fund
- Fund Family
- Venture Capital Fund
- Blue Chip Fund
- Back-end loading
- Income fund
- Stock Fund
- Specialty Fund
- Series fund
- Sector fund
- Prime rate fund
- Margin call
- Settlement currency
- Federal funds rate
- Sovereign Wealth Fund
- New fund offer
- Commingled funds
- Taft-Hartley funds
- Umbrella Funds
- Late-stage funding
- Short-term fund
- Regional Fund
- In-house Funds
- Redemption Price
- Index Fund
- Fund Domicile
- Net Fund Assets
- Forward Pricing
- Mutual Funds Distributor
- International fund
- Balanced Mutual Fund
- Value stock fund
- Liquid funds
- Focused Fund
- Dynamic bond funds
- Global fund
- Close-ended schemes
- Feeder funds
- Passive funds
- Gilt funds
- Balanced funds
- Tracker fund
- Actively managed fund
- Endowment Fund
- Target-date fund
- Lifecycle funds
- Trust fund
- Recovering funds
- Sector funds
- Open-ended funds
- Arbitrage funds
- Term Fed funds
- Value-style funds
- Thematic funds
- Growth-style funds
- Equity fund
- Capital preservation fund
Most Popular Terms
Other Terms
- Floating Dividend Rate
- Flight to Quality
- Real Return
- Protective Put
- Perpetual Bond
- Option Adjusted Spread (OAS)
- Non-Diversifiable Risk
- Merger Arbitrage
- Liability-Driven Investment (LDI)
- Income Bonds
- Guaranteed Investment Contract (GIC)
- Flash Crash
- Equity Carve-Outs
- Cost of Equity
- Cost Basis
- Deferred Annuity
- Cash-on-Cash Return
- Earning Surprise
- Capital Adequacy Ratio (CAR)
- Bubble
- Beta Risk
- Bear Spread
- Asset Play
- Accrued Market Discount
- Ladder Strategy
- Junk Status
- Intrinsic Value of Stock
- Interest-Only Bonds (IO)
- Interest Coverage Ratio
- Inflation Hedge
- Industry Groups
- Incremental Yield
- Industrial Bonds
- Income Statement
- Holding Period Return
- Historical Volatility (HV)
- Hedge Effectiveness
- Flat Yield Curve
- Fallen Angel
- Exotic Options
- Execution Risk
- Exchange-Traded Notes
- Event-Driven Strategy
- Eurodollar Bonds
- Embedded Options
- EBITDA Margin
- Dynamic Asset Allocation
- Dual-Currency Bond
- Downside Capture Ratio
- Dollar Rolls
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