September17 , 2021

What are hedge funds?

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A hedge fund is a pool of investment which majorly deals in liquid assets. It is made by the contribution of big investors. Professional managers operate the fund and they are motivated by a specific set of goals. The most major goal is to minimize the risk of investment and maximize the outcome. Because of this specific nature of funds, people only with a certain amount of money can invest in these funds. The funds are so complex in nature that majorly institutions, investors (who have some kind of link with the manager) or manager themselves invest in it.

Hedge funds mostly get extensively secured, as they usually do not get registered in the main stock exchanges. Although exponentially large hedge funds might have to register with the stock exchange. There are two ways to establish investment structure: LLC( limited liability company) or LP (limited partnership). LLC is a system where the whole company is responsible and the individual investor is not the only one responsible for funds. LP is an investment structure where investors themselves are responsible for the funds they have invested.

Regardless of the investing structure, the hedge fund is  mainly managed by the manager who supervises and invests the finances into different places to attain the set goal for the fund. Hedge funds of different categories have diverse goals, like the  funds that invest in long only equities they are only used to buy common stock and they don’t sell short. A goal which is familiar for almost all kinds of hedge funds is their main focus is market direction neutrality. This means they keep trying to make assets regardless of this fact the market is going up or down. Managers working for hedge funds are more like dealers.

The name hedge funds was given by the investors who have both short and longs stocks. As they make sure they make profit despite the fact of market fluctuations which is called hedging. With the passage of time hedge funds have different assets, securities and structures to deal with it.

How Hedge Fund Operates

Hedge fund’s main formation is partnership pool or investment. A manager who handles funds invests the money in different equities and securities, that will be able to reach the goals of the fund. Manager of a hedge fund tells the plan of action to the investors and then the investor who is convinced expects the manager to stick to the given strategy. The plan of action can have a hedge fund which has short and long on all the stock they have. There can be a hedge fund that particularly world in a certain kind of investment, which can range common to a patent stock.

Although, the biggest difference between hedge funds  and mutual funds is that accredited investors can always have them. To become an ‘accredited investor’ an investor must be equipped with these qualifications. A personal per annum earnings of 200,000 dollars or more.These earnings have to be of a single person, if you are married you are supposed to have a combined earnings of 300,000 dollars or more per annum. Your personal net worth should be over 1 million dollars. This net worth can be combined with your spouse and the spouse has to be part of a hedge fund. Another way to go is having an employee benefit plan of 5 million dollars.

The structure of Hedge Fund

These are the basic constituents of hedge fund

  • Hedge funds are usually accessible to investors with the net worth of 1 million dollars.
  • They take part in other leverage of funds too, for example borrowed money.
  • They already have investments in stocks, mutual funds or bonds. They can also invest in art, real estate, currency or food.
  • The investors have a fee structure of  “2 and 20” .

Kinds of Hedge Funds

The ultimate goal of hedge funds is to maximize net profit as much as possible and minimize the risk of loss. But there are different game plans to make it possible. The main game plan is what determines how much should be the investments.

Distressed Hedge Funds

The name suggests stress but these funds are not as distressing. They just deal with loan payments. Sometimes distressed funds are helpful for companies to buy securities like bonds. Distressed cheap bonds are also to buy cheap bonds which are expected to rise later. So, the whole point is that the deals made through this are risky, which might or might not be profitable.

Relative Value Arbitrage Hedge Funds

Hedge funds of this kind usually tend to buy securities, which are more guaranteed in terms of profits.

Equity Hedge Funds

Equity hedge funds are also called short or long equity funds. These funds try to go against the equity markets.

Managers invest these funds in the stock which are undervalued. The investment gets divided between shorting some stocks while investing in long stocks.

Macro Hedge Funds

Macro hedge funds are the simplest. Managers invest these funds in bonds and stock options. Sometimes they also invest them in currencies, if they see the chance of maximizing money there. It depends on variables which change with global trade situation, policies or interest rates. Though in the past these funds sometimes turn out to be a total disaster.

Hedge Funds and Disadvantages

  • As the investments are in huge amounts of assets in hedge funds, there is always a chance of big loss.
  • In comparison to mutual funds, hedge funds are much less in liquid.
  • Hedge funds usually require investors to invest and lock money for much longer than any other, typically for years.
  • The use of borrowed money in hedge funds is something which has the ability to change a small loss into a really big loss.

Like any other investments, hedge funds have their own risks. What makes it different from other investments, is the use of huge amounts of assets. Which can be doubled or lost in the blink of an eye.

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