Exclusive Hedge Fund article

Copyright BusinessEconomics.com 2012

Hedge funds are funds that seek to make investors money regardless of the direction in which markets are moving. It must  be recognized, however, that these funds are extremely diverse in their investment strategies, the markets in which they specialize and the size of funds under management – there is no such thing as a‘typical’ hedge fund. There are, nonetheless, some common characteristics. A hedge fund is usually run by a number of partners that form the fund, and they typically seek to raise capital from wealthy individuals or, increasingly, institutional investors prepared to put in around $500,000 to $10 million of risk capital. The hedge-fund partners will also be expected to put some of their own capital into the fund so that should they perform poorly then they themselves will participate in any losses. The hedge fund managers will usually make an annual charge of around 1 or 2 per cent of assets under management and in addition take a 15–25 per cent share of any profits made by the fund. Thus if the fund loses money, then fund managers’ rewards are significantly affected.
             
Hedge funds will often use derivative contracts such as futures and options contracts to establish significant leveraged speculative positions on the direction of markets. For instance, should they think a particular equity market will rise, they may buy stock-index futures or call options on that market. If, however, they think that a market will fall, then they may sell stock-index futures or put options on that market. In this way they have the potential to make money whether markets are rising or falling. This differentiates hedge funds significantly from mutual funds/unit trusts, the latter types of funds by holding shares and bonds are ‘long’ on the markets
hoping that prices will rise. A hedge fund, however, as well as having long positions on a market will also take short positions on a market or individual shares that they believe to be overpriced and likely to fall in price. If they are proved correct and the market or share falls in price, then they will make profits from such price falls.
            
It must be emphasized that there is an enormous variety of hedge funds pursuing very diverse investment strategies. There are, for example, so-called ‘macro funds’ that make major bets on certain economies. For instance, if a macro fund thinks that an economy is going to do well, then they may buy stock-index futures and currency futures on that country’s currency in the hope of making large gain should both the stockmarket and currency rise. Some funds specialize in buying or ‘shorting’ individual shares which they believe to be  under/overvalued. Other funds specialize in bond prices, commodity prices and foreign exchange rates, while yet others have a broad mandate to speculate in a whole range of markets and instruments. It is commonly thought that hedge funds take enormous risks in order to make large profits but this is an exaggeration,  there is a wide spectrum of investment strategies pursued by differing funds. It is true that some funds aim to make very high percentage rates of return by taking on high-risk strategies that are highly leveraged, but there are also many funds that are less ambitious seeking just to outperform the market at relatively low risk. Hedge funds also differ greatly in funds under management, the vast majority have between $200 million to $1 billion under management but some such as the Quantum Fund and the Tiger Fund have tens of billions under management.

Copyright BusinessEconomics.com 2012