Everything You Need to Know About Hedge Funds
The notion of “hedge funds” is the word used to describe investment partnerships. They are a high-risk and high-reward investment. They are an excellent way to make money. In simple terms, investors trust their funds to a manager who invests it according to an agreed upon plan. The goal is to minimize risks while leading to some of the highest returns. Their aim is usually to go against the market forces and make money in spite of how the market is performing.
Unique Characteristics
One primary characteristic of hedge funds is that only people with a lot of money can invest in them. A person must have a net worth of more than a million without evaluation of their house. Another characteristic is that a hedge fund can invest in anything. They are not limited to just stocks or bonds. Most of the top hedge funds have an investment in almost all areas of the global economy. The fee payment of a hedge fund is also quite different. The hedge fund manager can be paid according to how well the fund performs.
Another characteristic of a hedge fund is that they have unique term structures. For one, unlike other types, they do not have daily liquidity. It means there is a limit to how soon an investor can pull out their money. Subscription and redemption at a hedge fund are highly regulated. If the underlying investment has a high liquidity, the subscription and redemption will also be more frequent.
Most of these types of funds also come with a lock up feature. The lock up can be as long as two years. However, on average, most managers usually put it as a year. There are soft lockups and hard ones. The hard one means funds cannot be taken out before the lock-up period. In a soft lockup, investors can take out their money but with a penalty as high as ten percent.
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Measure of Performance
A hedge fund usually relies on an absolute return as the measure of performance. It is the reason why it’s especially attractive during financial difficulty. Most other types of investment funds evaluate their performance based on how others perform. Additionally, other types of funds are set to benchmarks to assess their performance.
A hedge promises a given return in spite of how bad the economy looks. Some of the funds that employ this performance measure include ones that are asset-backed. If a hedge decides to follow the absolute return strategy, it should strive to have positive returns annually. However, this may not always be possible due to volatility in underlying assets.
Some Facts about the Hedge Fund Sector
- There are about 15,000 hedge funds in the world today.
- Together, they are worth about $2.6 trillion.
- Hedge fund managers are usually people with an impeccable background and practice due diligence. The people who devote their money to them are investors that are a bit more sophisticated and have a deeper understanding of the process. However, the returns make it all worth it
- A hedge fund manager once almost caused the meltdown of financial markets. Bernard Madoff had misappropriated a great deal of investors’ money. Although many people had tried to bring up the issue, it was ignored. However, since then, regulations on fund managers have been tightened. Thus, it is one of the safest times to invest in these types of funds.
They Are Not As Bad as in the Movies
The entertainment industry has given these funds quite a bad name in recent times. Even media houses have not spared them. The managers of these funds are not sinister men seeking to destroy investors. In most cases, the managers will also have their money invested in the fund. Since these funds usually involve taking significant risks, we only hear about them when things go bad.
The fund manager has a lot of power and does need the approval of clients to trade their money. It ensures that he or she can take fast decisions that could bring a lot of funds in before others even realize it.
Considerations When Adding Hedge Fund To An Investment Portfolio
Although these funds are attractive, you must consider some things. For instance, in 2008, even low volatility funds were affected by the market downturn.
- When you plan to invest money in a hedge fund, you should analyze the risk/return of that portfolio. It is also important to evaluate gross and net exposure when investing in this type of fund. Ideally, the figure will never be above 100%. However, if a fund leverages its position, this could go beyond that.
- Always perform due diligence when planning to invest in a hedge fund. The first step here would be to request information. This is usually in the form of a single page summary of how the fund is performing. Additionally, the hedge fund manager sends a pitch book in the form of a power point and a questionnaire. All the documents can be sent together or individually. They help you analyze the strategy employed. It helps you to understand if it is a risk worth taking.
- Another aspect to think about when investing in a hedge fund is conducting background checks. Ensure that none of the managers have ties that affect their decision-making. It could eventually lead to huge losses for investors if they bet against themselves. Additionally, third parties need to be evaluated carefully. They include prime brokers, attorneys, and auditors.
Hedge Fund Are Good but TRICKY
Investing in a hedge fund is a complex issue. That is why it is only recommended for those with vast resources. If you put money in a hedge fund, you will also need a good financial advisor. It’s much like Forex Trading that has high risks, but the return on investments are also high.
Any detail you get when your money is in a hedge fund is crucial. One reason is that these funds have some of the highest degrees of secrecy. Although a hedge fund can give you a lot of money, it can also destroy you. Never invest everything you have in just one. An exciting development in hedge funds has been third party researchers. They allow people to know in a timely manner which ones are the riskiest. As these firms become better and regulatory oversight grows, hedge funds have become quite a safe and easy way to make money.