Published on:
January 12, 2023

What Is A Hedge Fund?

A hedge fund is a limited partnership of private investors who pool their money together to be managed by experienced fund managers. The money raised by this fund is used to invest in stocks, bonds, futures, options, and other securities, and these securities are used to reduce the risk of volatility in the market.

Why Should One Invest In Hedge Funds?

Investment in hedge funds is frequently viewed as a dangerous alternative since it typically has a high minimum or net worth requirement and frequently targets wealthy clientele.

The manager of the fund frequently constructs a hedged bet to offset any losses in the fund's core holdings by investing a fraction of the fund's assets in the opposite direction of the fund's primary objective. To compensate for any losses in cyclical stocks, a hedge fund that focuses on a cyclical industry will use the profits of non-cyclical companies, such as travel, and may invest a portion of its assets in the non-cyclical sector, such as energy.

Hedge funds use riskier strategies and leverage their holdings by investing in derivatives such as options and futures. Many hedge funds are attracted by their managers' reputations in the exclusive world of hedge fund investment.

A hedge fund investor is typically considered an accredited investor, necessitating a minimum level of income or assets. Institutional investors like pension funds, insurance firms, and affluent people are typical investors.

These investments are regarded as illiquid since the lock-up period, or the requirement that investors retain their money in the fund for at least a year makes them common. Furthermore, withdrawals may be permitted only on a limited basis, such as every quarter or every two years.

Types Of Hedge Funds

Hedge funds concentrate on carefully selected investments and security pools that are primed for profit. The four typical hedge fund subtypes are as follows:

Global macro hedge funds are actively managed investment vehicles that seek to profit from market swings caused by political or economic events.

A global or country-specific equity hedge fund may invest in successful stocks while selling short overvalued equities or stock indices to protect itself against equity market falls.

A relative value hedge fund seeks to profit from short-term changes in the values of comparable securities by exploiting pricing or spread inefficiencies.

An activist hedge fund invests in firms to increase the stock price by demanding that expenses be reduced, assets are reorganized, or the board of directors is replaced.

Common Hedge Fund Strategies

Hedge fund strategies cover a wide range of risk appetites and investment philosophies by utilizing a diverse range of investments such as debt and equity securities, commodities, currencies, derivatives, and real estate.

Common hedge fund strategies include equity, fixed-income, and event-driven goals and are categorized based on the manager's preferred method of investing.

In a long/short hedge fund strategy, investors go long and short on two rival companies in the same industry based on their relative valuations. Pairs trading is a variation of this strategy.

By having both long and short positions in fixed-income assets, a fixed-income hedge fund strategy tries to preserve capital while providing investors with consistent returns with low monthly volatility.

A strategy used by event-driven hedge funds capitalizes on momentary stock mispricing brought on by corporate events like reorganizations, mergers, and acquisitions, bankruptcies, or takeovers.

Hedge Fund Manager

A hedge fund manager is a firm or individual who manages, invests in, and oversees the activities of a hedge fund. Given the potential for great fortune, managing a hedge fund might be an appealing career path. They must think about how to have a competitive advantage, a well-defined investment strategy, sufficient capitalization, a marketing and sales plan, and a risk management strategy to be successful.

Hedge Funds Vs Mutual Funds

1. A mutual fund is not the same as a hedge fund. Hedge funds raise capital from HNIs or UHNIs, with larger ticket sizes compared to retail investors' portfolios with MFs. Mutual funds raise capital from the general public.

2. Mutual fund managers are prohibited from receiving performance fees, which are a type of profit-sharing. However, this is a standard procedure in hedge funds.

3. The MF business is tightly regulated about investing in securities because the general public is engaged, but hedge funds are not subject to the same level of regulation as MFs. Therefore, given the dangerous nature of hedge funds, retail investors should avoid them.


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Updated on:
March 10, 2023