An alternative investment, Hedge Funds are a form of fund that everyone has heard of but not everyone fully understands. In this article, Staff Writer Hannah Stevenson offers a brief overview of Hedge Funds and the benefits they provide for a seasoned investor.
Hedge Funds are a form of investment fund that pools its funds from multiple accredited investors and institutions, then uses this money to actively generate return, known as alpha, for investors. This is measured historically, and as such the fund aims to generate greater returns than previously through a series of investments.
Often, Hedge Funds are a short term investor but a long term investment, with investors usually putting large amounts of money into the fund and seeking to generate high alpha in return. When investing its pooled funds, Hedge Funds often take long term investment options and aim to make the maximum return on them before selling them short, which is what the first Hedge Fund was initially used for. After all, the fund is named after the strategy of attempting to reduce an investment’s risk whilst maximising its return- known as hedging.
Today, there are many types of Hedge Funds, and some also use longer term investing to generate alpha. There are also types of Hedge Fund that use leverage in both domestic and international markets with the goal of generating high returns, which is a riskier strategy than traditional hedging techniques. Thanks to such risker investment practices and their complex structures, Hedge Funds are considered an alternative investment. One factor that links all Hedge Funds is their focus on Market Neutrality: their aim to generate alpha regardless of the market direction at the time.
As such, Hedge Fund Managers are often more like traders than traditional Fund Managers. They usually receive 2% of the fund’s assets and 20% of its profits every year; the 2% of assets is a controversial figure, as it means that even if the fund loses money, the manager will still receive a significant portion of its worth. However, many Hedge Fund Managers manage their own money alongside that of their clients, and as such there is often an element of personal risk involved in managing a Hedge Fund, and the skill needed to successful generate alpha in this space is immense, so many would say that such a payment structure is a small price to pay.
Ultimately, due to their unique position in the investment market, and the fact that they operate under less regulation than other funds, Hedge Funds are only accessible to certain experienced and accredited investors. Hedge Funds also typically use riskier investment tactics, more volatile assets and a more complicated portfolio construction, and as such it is important that investors understand the risks involved in managing such a fund. However, for those with the knowledge, experience and capital, Hedge Funds can bring strong returns and act as a useful vehicle for managing a diverse range of assets.
For those interested in finding out more about Hedge Funds, AI offers a range of articles, interviews and insight, including our yearly Hedge Fund Awards.