Have you ever thought about putting your money into a hedge fund? Sounds like an interesting thing to do—especially if you have spare cash hanging around.
So what’s a good hedge fund definition? A hedge fund is an alternative investment that involves a pool of funds that use many strategies to secure so-called alpha returns for their investors.
Hedge funds are managed with both derivatives and leverage on national and global markets to achieve higher returns than a fixed benchmark.
So how can you benefit from them? Here’s everything you need to know about the advantages of a hedge fund.
It is good to understand that hedge funds are usually more accessible to certified investors because they require less regulation from the SEC than other funds.
However, hedge funds can be more expensive than traditional investment funds and can limit investments to high net worth investors and other sophisticated investors.
Several hedge funds have had extraordinary growth curves over the past 20 years. But many have also been linked to several controversies.
The performance of some hedge funds that beat the market was lauded in the 1990s and early 2000s. However, after the financial crisis, many hedge funds fared worse because of fees and taxes.
Hedge funds are designed to take advantage of great opportunities in the market. These are grouped according to investment style. A considerable variety of risks can be attributed to each of these investment styles.
Hedge fund investments are usually illiquid because they require investors to hold their money for one year at a time in the fund, known as a lock-in period. Exits can take place at appropriate intervals, approximately quarterly or semi-annually
Fame and Fortune In the 1990s
Prominent money managers left the traditional investment fund industry in droves in the early 1990s to pursue fame and fortune as hedge fund managers.
This was inspired by an article called “The Institutional Investor,” which described the performance of Julian Robertson and his Tiger Fund. However, many big hedge funds, including Robertsons, failed spectacularly in the late 90s, leading to a sharp decline.
Since then, the hedge fund industry has grown significantly. Hedge fund trends have evolved to maximize returns, with many funds moving away from the Jones strategy that focused on stock selection in conjunction with hedge funds and opting for riskier strategies based on long-term leverage.
The market is now huge. In Canada alone, it exceeds $3.2 trillion. The number of operational hedge funds has also increased significantly.
Hedge Funds Today
Estimates of the number of hedge funds active today vary. There are about 10,000 hedge funds today. This is up from 2002, when there were about 2,000 hedge funds.
People are weighing up growth vs value investing when trying to determine if they should keep their money safe with a hedge fund manager.
The investment universe of hedge funds is limited by their mandate. They are allowed to take money only from qualified investors (i.e., individuals with an annual income of over $200,000 in the last two years and a net worth of at least $1 million, including their primary residence).
Hedge funds invest in land, real estate, equities, derivatives, and currencies. Investment trusts, on the other hand, hold shares and bonds. Hedge funds use borrowed money to boost their returns and, depending on their strategy, allow them to hold aggressive short positions.
As we saw during the 2008 financial crisis, leverage can wipe out a hedge fund. The effects of the Global Financial Crisis are still being felt today. It is arguably one of the most significant events since the 1929 Wall Street Crash.
The Risk Can Pay Off
This wide margin may sound risky at times, and it is. There have been some spectacular financial blow-ups involving hedge funds. But the flexibility of hedge funds has resulted in some very talented money managers generating astounding long-term returns.
It is important to note that while most hedge funds try to reduce risk, the target of all hedge funds is to maximize ROI (return on investment). Indeed, when hedge fund managers make speculative investments, they carry more risk than the market as a whole. Since hedge funds employ dozens of different strategies, it is incorrect to say that they hedge against all risks.
Focused investment strategies can expose a hedge fund to huge losses. The use of leverage (borrowing) can turn a small loss into a significant loss. Some hedge funds require investors to hold their money for years.
A hedge fund manager is known for a typical 2:20 pay structure, in which a fund manager receives 2% of assets and 20% of profits each year.
It is this 2% figure that attracts all criticism, but it is not hard to see why. For example, a manager managing a $1 billion fund can collect $20 million in compensation per year without lifting a finger. Even if they lose money, they still get 2% of their assets.
However, there are mechanisms in place to help protect those who invest in hedge funds. There are fee caps that deter managers from taking excessive risks. Over time, fee restrictions will be used, like high-water marks, to prevent portfolio managers from getting paid the same returns over and over again
Hedge Fund Definition
What is a good hedge fund definition? It’s an investment vehicle that can win you some serious returns.
But only you if you do your research. Always get as much information as you can from the dealer about the investment before you put your money where your mouth is.
Hedge funds can be a risk, but the volatility means you can win big—especially if you ride the right waves. This is one of the best reasons to start a hedge fund.
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