Pooling money from investors, hedge funds invest in securities or other kinds of investments, the aim being positive outcomes. Hedge funds, not regulated as stringently as mutual funds and by and large have more latitude than mutual funds to go after investments and strategies that may accelerate investment loss risk. Hedge funds are restricted to well-heeled investors who can afford higher fees, hedge fund investing risk, and institutional investors who embrace pension funds.
A hedge fund can also be understood as an investment firm that uses sophisticated strategies concerning short selling, derivatives, leverage, and alternative asset classes to return yields for investors. Not only are hedge funds more complex relative to traditional mutual funds, but they are also regulated to a lesser degree and tend to look rather obscure.
As a result, investors might get the feeling they do not exactly understand what they are supposed to do. As a consequence of this, hedge funds cater to high net worth individuals, leaving the run-of-the-mill investor out in the cold.
Investing in hedge funds – teaser
It is indeed possible to invest in hedge funds. However, there are limitations as to the king of investors constituting a hedge fund’s investor pool. As a rule, it is quite challenging for individual investors to access a high-performance hedge fund. This compels many to either look for oblique methods of investing in hedge funds or entirely to abandon this dream.
Hedge funds: objective & features
A common topic among most mutual funds is their neutrality as to market direction. Since they expect to make money regardless of the market trends up or down, hedge fund management teams are more akin to traders than classic investors. A few mutual funds use these techniques to a greater degree than others. However, not all mutual funds go for actual hedging.
There are a number of essential features setting hedge funds apart from other pooled investments. The most conspicuous feature is the limited availability of hedge funds to investors.
Qualified or accredited investors
Hedge fund investors are expected to meet specific net worth requirements – as a rule, a net worth in excess of $1 million or a yearly income in excess of $200,000 for the preceding two years.
Wider investment capability
The investment capability of a hedge fund is restricted only by its mandate. Real estate, land, currencies, derivatives, and alternative assets – there is little a hedge fund cannot invest in. Conversely, mutual funds usually have to keep fixated on socks or bonds.
Frequent leverage use
Hedge funds frequently use leverage or borrowed money, magnifying their returns, possibly exposing them to a broader range of investment risk. This was shown during the Great Recession.
In the subprime meltdown, hedge funds were particularly impacted owing to increased exposure to accelerated exposure to collateralised debt obligations and high leverage levels.
Fee structure
Hedge funds charge both a performance fee and an expense ratio. The common fee structure is called two and twenty – a 2% asset management fee and a 20% cut of yielded gains.
There are a number of particular features demarcating a hedge fund. However, they are private investment vehicles permitting only rich individuals to invest. The wide capability is sometimes risky, just like it sounds. A handful of prominent financial blowups have concerned hedge funds. Be that as it may, the flexibility given to hedge funds has caused a few of the most promising money managers to produce spectacular long term returns.
Two & twenty structure
The target of acid-laced criticism is the 2 and 20 manager compensation scheme – employed by most hedge funds.
The 2 and 20 compensation structure implies that the hedge fund’s manager goes for 2% of assets, and 20% of profits annually. It is not hard to see why the 2% gets the criticism.
Regardless of the hedge fund manager losing money, the expert still pockets a 2% AUM fee. A manager overseeing a billion-dollar fund could be earning $20 million yearly in compensation without stretching a muscle. Even wiser is the instance of the fund manager who makes $20million dollars even as the fund loses money. They are then obligated to explain the reason why account values plummeted even as they got paid to the tune of $20 million dollars. A tough sell, it generally does not make the cut.
In the hypothetical instance above, the fund charged no asset management fee, rather taking a higher performance cut. This affords the hedge fund manager the opportunity to make more money alongside investors. Regrettably, this no-asset-management-fee-structure is hard to find in the prevailing hedge fund world. As a result, the 2 and 20 structure still holds fast, notwithstanding the number of funds that are taken up with a 1 and 20 setup.
Kinds of hedge funds
Hedge funds may follow different degrees of strategies, embracing equity, macro, relative value, activism and distressed securities.
A macro hedge fund invests in bonds, stocks, and currencies to profit from macroeconomic variable change, like global interest rates and economic policies across nations.
An equity hedge fund could be country-specific or global. It could invest in attractive stocks whilst hedging against equity markets downturns , by shorting overvalued stock for stock indices. A relative value hedge fund takes advantage of the inefficiencies of price or spreads. Aggressive growth, income, value, emerging markets, and short selling are among other hedge fund strategies.