What is a hedge fund? While many of us stumble on news about hedge funds every day, not everyone knows what a hedge fund is, how it works, and how is it different from other funds that exist (like mutual funds). So, to shed some light on hedge funds, we have compiled a couple of facts, that explain this mechanism of the investment world.
Hedge fund managers usually invest their own money in their funds, and in this way, they can establish an equality between them and other investors–accountability if you will. Obviously, being a hedge fund manager is a rather difficult position, because you’re not only responsible for your own money, but for a host of friends, co-workers, and clients’ fortunes as well.
However, taken into account that most hedge fund managers are millionaires and a select few (about 40) even billionaires, the game is worth the candle, so to speak. If you’re still asking the question “What is a hedge fund manager?“, you can check that link out further.
Let’s move on and tackle the question “What is a hedge fund?” on the following slides:
Hedge funds vs. Mutual Funds
In the investment world, a mutual fund is the closest peer to a hedge fund. They both have many things in common like used investment instruments. Both hedge funds and mutual funds invest in securities like equities or debt securities (for example bonds). Also, hedge funds and mutual funds are open-ended, both offering the possibility for investors to withdraw their money at any time (however, usually investors prefer to keep their money in a fund for some time in order to achieve a higher return).
Nevertheless, a hedge fund is a more sophisticated mechanism. It has more money invested in it, or assets under management, and while a mutual fund can have many investors, a hedge fund usually involves a restricted number of people and is not publicly traded.
Assets under management
A hedge fund has huge sums of money invested in it. Hence, a hedge fund has much higher returns. Some hedge funds might have billions of dollars in assets under management. Assets under management is one of the first metrics used to evaluate the strength of a hedge fund, since it denotes its popularity aside the return it yields to investors.
Requirements for investors
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Currently, U.S. law does not have any regulations imposed on hedge funds. However, some laws are applied to determine the possibility of an investor to join a hedge fund. Because hedge funds have large AUM figures, investors in them are required to be wealthy people, with a certain annual income, not to mention with at least $1 million in net assets.
Investment Strategies
The lack of regulation by law, gives hedge funds an amount of freedom in their investment strategies and moves. Since the appearance of the first hedge funds at the beginning of the last century, these strategies have evolved, and currently each hedge fund has its own strategy that is applied for achieving returns. Some hedge funds are focusing on some particular industries or fields (like energy, oil and gas, technology, etc.), while others pay attention to each company in particular, analyzing the events that might improve their financial situation and bring returns to investors as a result.
Risk Management
Before we mentioned that the word “hedge” means protection against a loss by involvement in more than one part of an event that might cause this loss. Well, hedge funds usually use diversification of their portfolios in order to be able to cover for some losses that might occur. After all, the hedge fund is making money based on speculation, which is highly risky, so diversification remains one of the most efficient strategies in risk management.
