In layman’s terms, hedge funds can be referred to as a pool of money that is to be invested in various positions, exchange of stocks, or engaging in trade bonds, convertible securities, commodities as well as derivative products. As evident from the terms, the primary aim of hedge funds is to make use of alternative investment methodologies so as to protect the investors’ money from the action of volatile markets. Some of the most sought-after hedge fund strategies are global macro, Convertible Bond Arbitrage (CBA), the Fund of Funds Approach, and the Equity Market Neutral (EMN).
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What is Hedge Fund?
In a more operational sense, the concept of a hedge fund can be defined as a form of private investment partnership and funds. The main purpose of these collected funds is investment or trade-in both listed and unlisted derivatives by making use of numerous hedge fund strategies. A basic line of difference is present between hedge funds and mutual funds. Though both types of funds share a common cash pool, hedge funds are available more on a private basis, unlike mutual funds. Three different types of hedge funds are demarcated here:
- Macro hedge fund: Such funds mainly invests in stocks, currencies, and bonds in expectation of gaining from the alterations in the macroeconomic variables functional within the concerned country, including the global interest rates and changing country policies.
- Equity hedge funds: These types of hedge funds are found to be global or country-specific. These also invest in various appealing stocks, though they attempt to lower the overvalued equities or stock indices with the aim of protecting the investors’ benefits from market downtowns.
- Relative-value hedge: Such types of hedge funds takes account of the price comparisons as declared by various organizations and direct market studies. After careful inspection, the relative-value hedge funds invest in a maximum profit-making venue determined by employing aggressive growth income, emerging market values, short-selling, etc.
Up to 2014, 158 alternative investment funds are enlisted in hedge funds in India. Some of the hedge fund examples are Munoth Hedge Funds, Forefront Alternative Investment Trust, IIFL Opportunities Funds, etc.
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Functions of Hedge Funds
The functions of the hedge funds can be understood from the following:
- Positive return investment: The hedge funds are functional during both the rise and collapse of the equity and bond markets of a country.
- The investors’ affairs and investments in hedge funds remain protected due to reduced total portfolio risk and overall volatility.
- The hedge fund plans are not rigid as it allows investors to customize their investment needs and patterns to fit their specific goals through the number of investment strategies deployed.
- The world’s best investment managers provide guidance and tailor investment plans to suit the investor’s needs.
Similar to any other investment strategy, hedge funds are not devoid of challenges. The risk of huge losses accompanies the investor with a gigantic investment in hedge funds. The investors need to keep their money in escrow accounts for multiple years. Moreover, compared to mutual funds, the hedge fund has lower liquidity. Concisely, the hedge funds are the least regulated and function with minimal transparency, which ultimately elevates risks for the investors. Even though the investors may get benefitted from huge profits, the chances of transforming a small loss into a huge one are manifold. Hedge funds can only be accessed by a handful of accredited investors, whereas mutual funds are open to anyone willing to invest. The short-term gains are the focus of hedge funds. According to market experts, mutual funds are far less risky and ensure long-term benefits as compared to hedge funds.
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Frequently Asked Questions on Hedge Fund
What is the process of gaining profit in the hedge funds?
A hedge fund employs a fee structure that is based on the assets under management that, in turn, are paid by the fund investors. A determined amount along with the positive returns that exceeded the declared benchmark is paid to the funds. These short-term gains are the major benefits obtained in hedge funds.
Name the hedge fund strategies involved frequently in the investment process.
Numerous hedge fund strategies are functional in the investment procedure, such as the long or short equity strategy, the Equity Market Neutral (EMN), and the Volatility Arbitrage.
Why investing in hedge funds are not recommended by market specialists?
The shady nature of the hedge funds, along with the increased risk of loss, makes them unsuitable for investors looking for long-term gains in the market. Also, the hedge funds can only be accessed by accredited investors. Though, no such barriers are described in mutual fund investments.
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