Since the start of the 21st century, investment in hedge funds has grown dramatically. In terms of the investments and an investor, a hedge fund is a financial partnership that uses pooled funds and uses various kinds of strategies that help the investors gain profits. A hedge fund gives its investors a wider variety of financial products to invest in than mutual funds.
1. How do Hedge Funds work?
In layman’s terms, a hedge fund is an alternative investment fund. People who start a hedge fund pool money from the investors and invest it to rope in profits. Traditionally, hedge funds are managed by institutional investors who have a knack for utilizing various nontraditional strategies and mitigating risks.
A Hedge fund is designed to draw profits regardless of the market position. Typically, in the finance world, hedging means to limit or reduce the market risks for an investment to make it more secure and successful despite the market instabilities.
Hedge funds generally show a preference for public market investments and are known to use unknown or nontraditional trading techniques like derivatives or short selling.
2. How do Hedge Funds Make Money?
Apart from the management fees, hedge funds also collect performance fees from their investors. The percentage of these fees can vary from fund to fund, but typically, it follows a 2-and-20 rule.
Management Fees-
The management fees are generally calculated as a percentage of assets under management. This is typically 2%. The management fees are intended to manage all the daily expenses and overhead and are collected from the investors regularly.
Performance Fees-
The performance fees are calculated as a percentage of profits incurred from investing the money. This percentage is typically around 20%. The performance fees are the incentives for hedge funds for drawing in profits and are offered to the employees as a reward.
3. What are the Kinds of Hedge Funds Strategies?
Hedge funds are known to take nontraditional approaches to trade and make profits inspite of the market positions. Here are the four most common strategies used by hedge funds-
Equity-
Equity is among the most commonly used hedge fund strategy. Hedges that use equity as their strategy balance long and short positions in the public markets to drive higher profits and reduce the risks. Under equity, market neutral, long-short, and short-long are the three popular subcategories.
Event-Driven-
An event-driven hedge fund is a fund that mostly invests in a company’s stock when they believe that a major event or a one-time event in that company’s history will greatly impact their security prices. This event could be its acquisition or bankruptcy. Merger, arbitrage, and distressed funds are some of the popular subcategories of event-driven investments.
Macro-
Macro funds mean investing in a much wider view of the securities. This could range from stocks, bonds, commodities, and derivatives. Managing a macro fund is generally predicting how global forces like weather, politics, or warfare could cause a shift in the financial markets.
Relative Value-
A relative value is a newer strategy where one requires access to the market data and finds inconsistencies and errors in how the market is pricing the individual strategies. The relative value focuses more on the market behavior as a whole rather than a single company. Convertible arbitrage and volatility arbitrage are two of the popular sub-strategies in relative value.
4. What are the Advantages of Hedge Funds?
Hedge funds are proven to be much more beneficial to investors than any other investment option. Here are some of the reasons why-
Hedge Funds are Flexible-
Unlike the other kinds of investment options like mutual funds, hedge funds are much more flexible. The reason is that Securities and Exchange Commissions (SEC) generally do not put much focus on hedge funds. People generally don’t trade hedge funds publicly which makes it so much more flexible, as there is no institutional body regulating its performance.
A hedge fund can use any strategy, like short selling, derivatives, and leverage, and invest across various platforms.
Aggressive Investment Strategy-
When talking about hedge funds, one thing is clear- hedge funds portray an aggressiveness in investment. This helps them realize more gains. Some of these investment strategies include short selling, using borrowed money to buy more assets, and derivatives.
5. 4 Largest Hedge Funds-
BlackRock-
In the world of hedge funds, BlackRock is one of the most respected giants. This hedge fund was founded by Larry Fink, Susan Wagner, Robert S. Kapito, and others. This hedge fund firm has grown to be so large that its assets under management value to about $9.5 trillion on its asset books.
AQR Capital Management-
AQR Capital Management was founded by Cliff Asness, David Kabiller, John Liew, and Robert Krail, all of whom are highly-regarded experts in financial markets. AQR Capital Management has been around since 1998 and serves institutional investors, financial advisors, and high net individuals.
Bridgewater Associates-
Bridgewater Associates was founded in 1975 by billionaire investor, Ray Dalio. Over the years the firm has grown to be one of the most trusted ones with about $150 billion in assets under management as of March 2021.
Renaissance Technologies-
This hedge fund was founded by Howard L. Morgan and Jim Simons in 1982. The firm quickly became a massive hit by handling about $165 billion in client assets. Located in Long Island, New York, Renaissance Technologies employs about 300 people, more than 150 of whom handle the investment advisory functions.
