What Do Hedge Funds Do?

A hedge fund is open only to a limited range of investors, and it is permitted by regulators to undertake a wider range of investment and trading activities. Each hedge fund is unique and follows its own strategy, depending of the kind of investors and the amount of money involved. It uses advanced investment strategies such as leveraged, long, short and derivative positions, in both domestic and international markets, for impressive gains at reduced risk. Hedge funds are generally set up as private investment partnerships and require a very large investment in the initial phase. Unlike mutual funds, hedge funds are unregulated as they cater to sophisticated and high profile investors. However, for an easier understanding, they can be considered as mutual funds for the super rich.
 
It is possible that the net asset value of a hedge fund runs into many billions of dollars. Hedge funds dominate certain specialty markets such as trading within derivatives, and as the fund managers make speculative investments, sometimes these funds can carry more risk than the overall market. The strategies followed by hedge fund investors vary enormously as many investors hedge against downturns in the markets, aiming to preserve capital and deliver positive returns under all market conditions. A macro hedge fund is considered to be more volatile, but faster growing than a distressed securities hedge fund. It invests in stock, bond markets, and other investment opportunities like currencies, and gets significant profits with alterations in global interest rates and countries’ economic policies. An equity hedge fund hedges against downturns in equity market by shorting overvalued stocks or stock indexes.
 
The hedge fund investment strategy changes from time to time as opportunities arise, in order to gain profit from events like initial public offerings (IPOs), fluctuation in market prices, hostile bids, and other major or minor event-driven opportunities. The approach is further diversified by inculcating various aspects of macro economics and international finance simultaneously to realize short and long-term gains. As big bucks are involved in a hedge fund, a careful inspection of all the important aspects becomes necessary from the investor's side.
 
The history of hedge fund dates back to 1949, when Alfred W. Jones used short sales and leverage techniques in combination. Later in 1952, created the first multi-manager hedge fund, by investing with several independent portfolio managers. He also started using the short-selling of shares, and in 1966, the Fortune magazine declared that his fund had outperformed all the mutual funds of its time, the reason being the higher rate of return as compared to all other mutual funds. Till 2005, hedge funds in the United States often relied on Section 4(2) and Rule 506 of Regulation D of the Securities Act of 1933. The primary reason for this was to avoid the registration of their securities, with the Securities and Exchange Commission of the United States (SEC). Hence, hedge funds escaped most of the U.S. regulation directed towards investments like mutual funds. In the European countries, the hedge funds are controlled by either regulating the type of investor or regulating the minimum subscription level required to invest in a hedge fund.
 
Benefits of Hedge Funds
Following are some of the major benefits of hedge funds.
  • Hedge funds generally provide higher returns and lower overall risk, as compared to the traditional investment funds.
  • They provide an ideal long-term investment solution.
  • Many hedge fund strategies are able to generate profits even in falling equity and bond markets.
  • Including hedge funds in a portfolio reduces overall risk and volatility, and provides diversification.

 An understanding and knowledge of the many different hedge fund strategies is essential to capitalize on the investment opportunities present in the market.

By Swapnil Srivastava - Buzzle.com