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7. |
What are hedge
funds? What makes them different?
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Hedge
funds are like mutual funds in
that they are pooled investment
vehicles (i.e. several investors
entrust their money to a manager)
and they invest in publicly traded
securities. However, there are
important differences between a
hedge fund and a mutual fund,
particularly as regards their
investment profile.
The term 'Hedge
Funds' is a loose description to
cover a wide range of investments
with very different approaches.
However, most Hedge Funds exhibit
the following features which
traditionally have distinguished
them from conventional funds:
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Conventional funds are generally
long-only in that they buy and
hold stocks; if the price of the
stocks go up they make money, if
the price of the stocks fall they
loose money. Hedge funds, however,
are often long / short funds which
means that in addition to buying
stocks they sell stocks which they
do not own they
short. If you short a stock you
are going to have to close out
that position at some time, you do
this by buying the stock. So if
you sell a stock at $10 and then
close out that transaction by
buying a stock at $11, you will
have lost $1. If you close out by
buying a stock at $8, you will
have made $2. The point is that if
you think a stock is going to fall
in price, you can short stock and
profit if you are right |
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Their primary aim
is to produce absolute and
consistent returns irrespective of
market conditions, in other words
they can buy stocks they think
will increase in value and short
stocks they think will fall in
value. They aim to make money in
both a rising and falling market |
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They
do not limit their investment
universe to equities. Some funds
may invest in commodities,
currencies, financial derivatives
such as futures and options,
emerging markets or distressed
securities for example |
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They usually trade
very actively trying to take
advantage of market anomalies |
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The managers are
usually highly incentivised
through performance fees |
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The funds have the
ability to borrow, which can
increase risk |
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They usually have
very high minimum investment (at
least $100,000 in most cases)
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