The fundamentals you need to know about Hedge Funds

If you’ve ever been in a surrounding where financial terms are flying around, you’ve definitely come across the term Hedge Fund. Since the 21st century, Hedge Funds have started becoming more and more relevant, and if you have a diversified investment portfolio, you most probably have invested in a Hedge Fund. But, what is a Hedge Fund?

What is a Hedge Fund?

Something of a very fancy term, a Hedge Fund is just a very strong partnership of investors. There’s usually a professional fund manager, who’s often known as the general partner, and then there are investors, who put money into the fund and are known as limited partners. Together, when the money comes along, it is called a Hedge Fund. So, if somebody asks you what is a Hedge Fund? – It’s basically just a situation where a manager and group of investors come together and start investing into various financial instruments expecting returns.

How is a Hedge Fund different from a mutual fund?

In a Hedge Fund, the limited partners contribute financially in terms of assets and the general partner invests them into the market, and they get returns out of it. You’re most probably asking right now, isn’t it the same as a mutual fund? It may sound like that, but that’s where the similarities end. Even though Hedge Funds are meant to minimize risk and increase profits, they are considered to be riskier and more exclusive with their investments.

Forming a Hedge Fund is also a bit more difficult legally, and usually requires high amount of investments. Lastly, a mutual fund is usually expected to yield returns for the investors, no matter the market, whereas this is not the case for Hedge Funds due to the risk involved.

Why is it called a Hedge Fund?

The name Hedge Fund speaks a lot about the nature of the fund that it is. Hedge Fund managers are usually allowed to involve themselves in trading techniques where in even though the market or stocks are not yielding returns as planned or forecasted – both for the positive and negative, the managers can hedge themselves by making long (if they can foresee a market rising) or short (if they anticipate that the market will drop) term investments.

The purpose of Hedge Funds may be to reduce risk, but it still traditionally involves a lot of risk.

Characteristics of a Hedge Fund

  1. Investment Portfolio – A Hedge Fund does not limit itself to investing into stocks and bonds. A Hedge Fund has the right and mindset to invest into pretty much anything ranging from land to foreign exchange (currencies) to real estate to derivatives and alternative assets too.
  2. Only for the rich peeps – A Hedge Fund is open to only well accredited investors and has a high buy in. You usually need to show an amount of assets or certain constant salary for a period to be able to enter a Hedge Fund.
  3. Risk involvement – Hedge Funds usually have risk involved and are for those who have high risk appetites though the span of the short- and long-term returns could be quite high. The best Hedge Fund to invest is in one which has no leverage and less risk involved.
  4. Complex fee structure – A Hedge Fund usually has a very complex fee structure. Instead of charging a service fee, there’s also a certain amount paid for the performance. This ratio is usually 2% and 20%. What this means is that, you must pay 2% of your returns for your asset’s management and 20% of any gains that you generate.
  5. Different types – There are different types of Hedge Funds depending on the various strategies that are involved. These include equity, macro, distressed securities, activism and relative value. All these Hedge Funds have different ways of working, and you should look at the strategies to find out which is the best Hedge Fund for you to invest in.

Why invest in a Hedge Fund?

It is often said by industry experts that those who have invested in Hedge Funds usually get high returns because of equally risky stakes. If you have a balanced and diversified portfolio, Hedge Funds can reduce any volatility and overall portfolio risks.

Through Hedge Funds, you can get in contact with the best of best when it comes to fund managers, and that usually means a nice network and even better returns.