Understanding Hedge Fund

A hedge fund is a limited partnership of private investors whose money is managed by professional fund managers who use a wide range of strategies, including leveraging or trading of non-traditional assets, to earn above-average investment returns.

Hedge fund investment is often considered a risky alternative investment choice and usually requires a high minimum investment or net worth, often targeting wealthy clients.

The term “hedge fund” defines this investment instrument as the manager of the fund often creating a hedged bet by investing a portion of assets in the opposite direction of the fund’s focus to offset any losses in its core holdings.

A hedge fund that focuses on a cyclical sector such as travel, may invest a portion of its assets in a non-cyclical sector such as energy, aiming to use the returns of the non-cyclical stocks to offset any losses in cyclical stocks.

Hedge funds use riskier strategies, leverage assets, and invest in derivatives such as options and futures. The appeal of many hedge funds lies in the reputation of their managers in the closed world of hedge fund investing.

An investor in a hedge fund is commonly regarded as an accredited investor, which requires a minimum level of income or assets. Typical investors include institutional investors, such as pension funds, insurance companies, and wealthy individuals.

Investments in hedge funds are considered illiquid as they often require investors to keep their money in the fund for at least one year, a time known as the lock-up period. Withdrawals may also only happen at certain intervals such as quarterly or bi-annually.

Hedge funds target select investments and pools of securities primed for gains. Four common types of hedge funds include:

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

An equity hedge fund may be global or specific to one country, investing in lucrative stocks while hedging against downturns in equity markets by shorting overvalued stocks or stock indices.

A relative value hedge fund seeks to exploit temporary differences in the prices of related securities, taking advantage of price or spread inefficiencies.

An activist hedge fund aims to invest in businesses and take actions that boost the stock price which may include demands that companies cut costs, restructure assets or change the board of directors.

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