Hedge Funds

Hedge Funds
Imran Baloch
Definition
An
aggressively managed portfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark).
Legally, 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. Investments in hedge funds are illiquid as they often require
Explanation
For the most part, hedge funds (unlike mutual
funds) are unregulated because they cater to sophisticated investors. In the U.S., laws require that the majority of investors in the fund be accredited. That is, they must earn a minimum amount of money annually and have a net worth of more than $1 million, along with a significant amount of investment knowledge.
You can think of hedge funds as mutual funds for
the super rich. They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more
Explanation Cont
It is important to note that hedging is actually
the practice of attempting to reduce risk, but the goal of most hedge funds is to maximize return on investment. The name is mostly historical, as the first hedge funds tried to hedge against the downside risk of a bear market by shorting the market (mutual funds generally can't enter into short positions as one of their primary goals).
Nowadays, hedge funds use dozens of different
strategies, so it isn't accurate to say that hedge funds just "hedge risk". In fact, because hedge fund managers make speculative investments,
FACTs About HF
Estimated to be a $1 trillion industry and growing at about 20% per year with approximately 8350 active hedge funds. Includes a variety of investment strategies, some of which use leverage and derivatives while others are more conservative and employ little or no leverage. Most hedge funds are highly specialized, relying on the specific expertise of the manager or management team. Performance of many hedge fund strategies, particularly relative value strategies, is not dependent on the direction of the bond or equity markets -- unlike conventional equity or mutual funds (unit trusts), which are generally 100% exposed to market risk. Hedge fund managers are generally highly professional, disciplined and diligent. Their returns over a sustained period of time have outperformed standard equity and bond indexes with less volatility and less risk of loss than equities. Investing in hedge funds tends to be favored by more sophisticated investors, including many Swiss and other private banks, that have lived through, and understand the consequences of, major stock market corrections.
An increasing number of endowments and pension funds allocate assets to hedge
Characteristics of HF
Hedge funds utilize a variety of financial instruments to reduce risk, enhance returns and minimize the correlation with equity and bond markets. Many hedge funds are flexible in their investment options (can use short selling, leverage, derivatives such as puts, calls, options, futures, etc.). Hedge funds vary enormously in terms of investment returns, volatility and risk. Many, but not all, hedge fund strategies tend to hedge against downturns in the markets being traded.
Many hedge funds have as an objective consistency of returns and capital preservation rather than magnitude of returns.
Pension funds, endowments, insurance companies, private banks and high net worth individuals and families invest in hedge funds to minimize overall portfolio volatility and enhance returns. Most hedge fund managers are highly specialized and trade only within their area of expertise and competitive advantage.
Hedge funds benefit by heavily weighting hedge fund managers remuneration
Hedge Fund Strategies

A wide range of hedging strategies are available to hedge funds.
selling short - selling shares without owning them, hoping
to buy them back at a future date at a lower price in the expectation that their price will drop.
using arbitrage - seeking to exploit pricing inefficiencies
between related securities - for example, can be long convertible bonds and short the underlying issuers equity.
trading options or derivatives - contracts whose values
are based on the performance of any underlying financial asset, index or other investment.
investing in anticipation of a specific event - merger
transaction, hostile takeover, spin-off, exiting of bankruptcy proceedings, etc.
Popular Misconception
The popular misconception is that all hedge
funds are volatile -- that they all use global macro strategies and place large directional bets on stocks, currencies, bonds, commodities, and gold, while using lots of leverage.
In reality, less than 5% of hedge funds are
global macro funds. Most hedge funds use derivatives only for hedging or don't use derivatives at all, and many use no leverage.
Benefits
Many hedge fund strategies have the ability to generate positive
returns in both rising and falling equity and bond markets.

Inclusion of hedge funds in a balanced portfolio reduces overall
portfolio risk and volatility and increases returns.

Huge
variety of hedge fund investment styles many uncorrelated with each other provides investors with a wide choice of hedge fund strategies to meet their investment objectives.
Hedge funds provide an ideal long-term investment solution,
eliminating the need to correctly time entry and exit from markets.
Adding hedge funds to an investment portfolio provides such
diversification not otherwise available in traditional investing
Volatility against each strategy

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Hedge Funds

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Hedge Funds

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Hedge Funds

Legally, hedge funds are most often set up as

An increasing number of endowments and pension funds allocate assets to hedge

Hedge funds benefit by heavily weighting hedge fund managers remuneration

Hedge Fund Strategies

transaction, hostile takeover, spin-off, exiting of bankruptcy proceedings, etc.

returns in both rising and falling equity and bond markets.

portfolio risk and volatility and increases returns.

Hedge funds provide an ideal long-term investment solution,

diversification not otherwise available in traditional investing

Volatility against each strategy

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