A hedge fund is defined as a form of investment fund which is aggressive and uses highly developed investment strategies to make as high profits as possible. Given the fact that a huge amount of money is required to institute a hedge fund, the fund is usually organized in form of private partnerships. The fund is not limited regarding the duration of investments in which it can be involved. Moreover, hedge funds can invest in virtually any available opportunity in the market provided there is a possibility of making returns.
Hedge funds are set up to ensure reduced risks and positive returns whether the market is in a boom or recession period. Before investors are allowed to invest in hedge funds, their financial position is evaluated to ensure it meets the requirements. It is important to note that due to the requirement that investors have to keep their money in the hedge fund for at least one year, hedge funds are in many cases liquid. The number of hedge funds has been increasing at a high rate in recent years.
Hedge funds have various characteristics that can be used to identify them. To begin with, hedge funds aim at ensuring that the capital of investors earns returns at all times. In this regard, ensuring the presence of returns as opposed to looking at the quantity of the returns is the emphasis of hedge funds. Moreover, the priority of hedge funds is to preserve the capital of investors. On the same note, it should be noted that to reduce the risk associated with any investment opportunity, hedge funds use several strategies. Consequently, hedge funds have flexible investment plans taking advantage of any opportunity that has returns and the lowest risks.
Hedge funds require a lot of money to invest and if any mistake is made a lot of money will be lost. As a result, the fund requires absolute dexterity in management and decision-making. Consequently, hedge funds are characterized by a highly qualified and experienced management team that makes investment decisions. This team usually makes investments in areas where they have a competitive advantage to enhance the probability of making returns. Additionally, investors themselves have to be accredited to ensure that they have experience in this kind of investment before being allowed to invest. Concisely, the hedge fund is a fund of experienced and qualified people. Hedge funds are tailored to secure investors against market downturns, and they deploy the best brains in the market to achieve this.
Hedge funds utilize many strategies to ensure maximum returns. However, the strategies change very fast, and categorizing them is a problem. Nevertheless, some major strategies can be identified. The first one is the global macro strategy. Hedge funds utilizing this strategy usually base their decisions on changes in government policies that lead to fluctuations in interest rates. Consequently, these hedge funds mostly invest in bonds or financial markets and equities. The strategy takes advantage of flexibility in macro events and invests in diverse markets thus making risk-adjusted returns. Regarding global macro strategies, there are two options that investors can choose from.
Firstly, investors may come up with a list of profitable investments from all other investment opportunities. These decisions are made by the managers using their experience in the field and the history of the opportunities. Secondly, the managers may choose to use software programs that use mathematical models to identify the opportunities that are worth investing in. Investors usually forecast the expected trend in national policies and take advantage of any opportunities arising from the same.
On the same note, there are instances when investors change their investment decisions depending on the prevailing conditions. Some opportunities where one can make good returns are not so predictable. Consequently, they have to be taken as and when they come. In this regard, hedge funds can use several investment strategies in different periods when worthy opportunities come up. These strategies depend on specific market events which are not predictable. Managers of various hedge funds are always on the lookout to identify whenever any event that might work to their advantage occurs.
Moreover, managers can decide to categorize the market into various segments depending on any criteria they may deem fit. Thereafter, the managers will watch movement in each market segment and invest where the probability of making returns is high. Another strategy that is commonly used by hedge funds is monitoring the market movements over some time and using the information collected to make investment decisions. Computer models or simple observations may be used to monitor market trends. Nevertheless, the main aim is to understand periods when various markets yield the highest returns and invest during these periods. The volatility of this strategy is high because market conditions do not remain the same over long periods.
On the same note, hedge funds usually take advantage of the misfortunes of various companies, especially during bankruptcy, and buy their shares at very low prices. The lack of perfect information in the market is essential in enabling the hedge funds to make high profits from these shares. This strategy is relatively non-volatile given that it is not dependent on market trends and hedge funds always have liquid cash to invest in any opportunity that comes up. Price differences in various securities can also be of benefit to hedging funds. Consequently, price movements are always closely scrutinized to ensure that any slight movement is noted.
It is the main aim of all hedge funds to minimize the risks involved in various investment opportunities to save the capital of investors. As a result, risk management is an integral part of hedge funds. Besides managers being very experienced in the issue of investment and risk management, hedge funds are also likely to have people whose sole job is to evaluate the risks of any investment. On the same note, hedge fund investors are accredited people who are fully aware of all the risks of the business. They will, therefore, be very cautious with where their money is invested. In this regard, state-of-the-art risk management strategies are deployed by hedge funds in evaluating risks. Assured returns of any magnitude are better off than high returns accompanied by high risks.
Hedge funds have many advantages that make them investments of choice for many investors. To begin with, while other types of investments are known to be non-profitable during economic recessions, hedge funds yield returns. Hedge funds are designed to yield returns in both scenarios of the business cycle, expansion, and contraction. Managers of hedge funds are given the task of ensuring that the funds always yield returns on capital invested no matter how small the returns may be. On the same note, hedge funds make use of very many strategies of investment. These styles are uncorrelated and each is best in different market conditions.
As a result, every investor is catered for in terms of having his or her objectives met. This is vital in ensuring that any changes in the market conditions do not affect hedge funds negatively. Moreover, given that hedge funds endeavor not to maximize returns but to reduce risks, their risk portfolio is lower than that of other investment funds. Similarly, it is the priority of hedge funds to ensure that returns on capital are consistent.
In this regard, hedge funds have higher returns on capital and greatly reduced risks as compared to other investment funds, especially traditional ones. Furthermore, hedge funds are tailored to monitor market trends and invest in various opportunities only when the time is right. As a result, investors do not have to keep on observing the market to ensure they enter or leave during the correct period. Consequently, investors in hedge funds are provided with the opportunity of investing in one place which will do the job of timing for them. In this regard, hedge funds are very good as a form of long-term investment.
Hedge funds may join together in a move aimed at ensuring that returns are earned consistently. In this regard, hedge funds from different sectors of the economy or even geographical places may combine forces to enhance diversification in investment opportunities thus reducing the risks of all hedge funds involved. The combination of various hedge funds is referred to as a fund of hedge funds. Funds of hedge funds offer a mode of investment with highly reduced risk which makes it attractive especially to insurance firms, private banks, and very wealthy families.
Funds of hedge funds are highly beneficial to investors because they can be able to know what to expect in advance as opposed to other modes of investment. Similarly, funds of hedge funds provide a better way for an investor to diversify his or her investment in different sectors of the economy given that it combines hedge funds from different economic fields. Moreover, managers of funds of hedge funds have the expertise to efficiently use the various strategies available. As a result, these funds can provide returns throughout the investment period. It is important to note that sometimes the returns are independent of the stock market conditions.
By pulling together resources, funds of hedge funds can highly minimize risks that would have been incurred by a given hedge fund and by extension decrease individual investors’ risk. Additionally, funds of hedge funds pull together expertise from various hedge funds.
This not only increases its profitability but also enhances effectiveness and efficiency in management. Investors are therefore saved from the trouble of going round and evaluating every hedge fund before making decisions on where to invest. This is because different hedge fund managers, who are highly qualified, combine their minds in making decisions and this reduces the chances of making investment mistakes. More importantly, funds of hedge funds offer an ample way through which an investor’s diversified investments can be managed by a single entity.
Nevertheless, it should be noted that hedge funds are not perfect as one may be made to think, especially after the above discussion. They have their fair share of drawbacks. Hedge funds usually charge exorbitant fees compared to other investment funds. This reduces the earnings of hedge funds thus reducing the returns that investors get. Similarly, hedge funds are not under any regulation to make public their operations. As a result, the financial or operational results that are found regarding any hedge fund are not necessarily true and fair. Consequently, the funds may provide false information about their performance to increase the number of investors. On the same note, many hedge funds recruit internal people to management positions. This is dangerous as it can lead to malicious activities.
In addition, other risks are still present in hedge funds despite their efforts to minimize risks. These risks are usually associated with the financial institutions that hedge funds work together with and are increased in times of crisis. It is important to note that hedge funds work closely together with their investment banks making them susceptible to any misfortunes of the banks. Consequently, during times of economic downturns, hedge funds find themselves on the receiving end after failing their investment banks.
Hedge funds provide opportunities for investors to easily diversify their investments without necessarily having to do it under several funds. They reduce the risk of investment besides ensuring that investors will always have returns on their capital. On the same note, the act of selecting the most qualified personnel is crucial in ensuring management efficiency. However, this is also expensive since qualified personnel has to be paid higher salaries. In addition, the lack of regulation opens hedge fund accounts to manipulation and investors might not be able to know the true and fair position of the fund. Consequently, care should be taken when choosing the hedge fund to invest in.