There are many investment options open to the public at large today. Each investment comes with a certain degree of risk, which more or less has a direct impact on the returns guaranteed to the investor. The world of investments grows larger every few years, with more investors opting for investments that give maximum returns with reasonable risk.
Hedge fund is another step forward in an attempt to diversify the investments, balance out risks, and maximize returns over a longer duration of time. However, given its novelty, one must understand the intricacies with which hedge funding functions.
So, is the hedge fund investment a good idea for you? What must one consider when looking to invest in a hedge fund?
What are hedge funds?
Given the biased and negative image of hedge funds in mainstream media, it is important to define what a hedge fund is. A hedge fund is a kind of alternative investment. This usually implies that the investment is made either in real estate, private equity, or commodities.
It’s a kind of alternative investment that involves pooled funds from different private investors. The goal of a hedge fund is to use different strategies such that all investors getting an active return.
Hedge funds get their name from the hedging techniques used by investors to ensure maximum absolute returns. However, today, the name usually implies any private or unregistered investment pool, since these funds aren’t required by the law to be registered. This is partially due to the fact that hedge funds don’t accept more than a 100 high-profile and high-net-worth investors at a time.
Objectives of a hedge fund
In a lot of ways, hedge funds are much like mutual investments. They’re both vehicles of pool investment and both work with publicly traded securities. But while mutual funds aim at relative returns, hedge funds aggressively seek out active returns, regardless of the investment benchmark. This feature is common to all and any hedge funds.
All this is to say that hedge funds are a great way to diversify one’s portfolio. They’re also a versatile manner in which one can set return goals. Since hedge funds give investors a chance to work towards active returns, one has the freedom to flex their hedge fund in order to ensure a set goal of, say 6–8% annual return.
Different techniques used in hedge funds
A lack of strict regulation gives investors more freedom when it comes to the different investment techniques. Each investor can look at the risks and potential profits and decide for themselves. Here are some of the common hedging techniques. Although hedging implies reducing risk, most of these techniques are used in order to maximize returns.
- Direct hedge: This is the simplest kind of hedging. This involves hedging together two assets that have similarities in trades and price movements. This allows investors to focus on groups or pairs of assets at a time. It is easier, as opposed to looking at performances of each asset, which can be time consuming for large scale investors.
- Static hedge: This is a kind of fixed hedge, that remains unchanged until the maturity of the fund. This hedge is constructed to reflect the target value of the investor for that particular asset upon maturity and requires no more adjustments. This hedge is generally applied to eliminate or reduce risk.
- Dynamic hedge: Sitting on the opposite end of the spectrum from static hedge is the dynamic hedge. As the name suggests, this hedge attempts to renew and change the inputs in any given asset. The changes are made to reflect the changes in the market in order to ensure the most profitable returns. This technique is employed both in profit assessment and risk management portfolios.
Risks in a hedge fund
Although “risks” don’t exist in the conventional sense, there are multiple conditions that have to be in favor of the investor for a hedge fund to work out the way it is intended. For one, hedge funds aren’t popular in bull markets. Mutual funds are more so preferred. However, given the singularity in the objective of a hedge fund, it is immensely popular in the bear market. This is because these funds hold shorter positions and are less volatile as opposed to mutual funds.
Another issue many investors might face is the liberation of the hedge fund. Given the prohibition on the advertising of hedge fund, few investors are aware of the existence of any hedge funds they may invest in.
Further, the freedom from registration that hedge funds enjoy comes from the upper limit of investors they allow. These investors are also required to be accredited, which means they must meet a minimum net worth standard.
There isn’t much to say about the liquidity of hedge funds either. Investors might find it difficult to withdraw their already invested funds at their time of choosing, since hedge funds have a strict period of lock-out.