Hedge Funds: An Overview
What is a Hedge Fund?
A hedge fund is a pooled investment vehicle that manages capital from accredited or institutional investors with the aim of generating high returns. Unlike traditional mutual funds, hedge funds have more flexibility in investment strategies, including the ability to use leverage, short selling, derivatives, and alternative assets.
Hedge funds are typically less regulated than mutual funds, allowing managers to pursue aggressive or complex strategies to maximize returns. They often charge performance-based fees in addition to management fees, aligning incentives between managers and investors.
Key Features of Hedge Funds
Accredited Investors Only: Usually limited to high-net-worth individuals or institutional investors.
Flexible Investment Strategies: Can invest in equities, bonds, commodities, currencies, derivatives, and alternative assets.
Leverage and Short Selling: Hedge funds may borrow capital or sell assets short to amplify returns.
Fee Structure: Commonly “2 and 20” — 2% management fee and 20% performance fee on profits.
Limited Liquidity: Investors often have lock-up periods during which funds cannot be withdrawn.
Common Hedge Fund Strategies
Equity Long/Short: Buying undervalued stocks and shorting overvalued stocks.
Global Macro: Making bets on macroeconomic trends, such as interest rates, currencies, or commodity prices.
Event-Driven: Investing in opportunities created by mergers, acquisitions, restructurings, or bankruptcies.
Relative Value/Arbitrage: Exploiting price differences between related financial instruments.
Quantitative/Algorithmic: Using mathematical models and algorithms to trade at high speed.