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What Is a Hedge Fund?

Tuesday, 05 Oct 2010 10:14 AM

Often wealthy or “high net worth” individuals opt for the investment avenue of a hedge fund. These funds generally result in large returns, mostly higher than the market average, and as a result, have become a favorite investment avenue for those with large capital to invest.
So, what is a hedge fund? Here are some details:
  • Hedge funds are mutual funds for the wealthy. One definition of a hedge fund is that it is an investment fund where the money to be invested is pooled  by a select few, numbering not more than 100. This money is then invested in a broad range of investment strategies for maximizing returns. The investment strategies are at times unconventional and, as the name suggests, a major hedge fund strategy is hedging the possible risks arising out of other higher-risk investment decisions. 
  • Hedge funds are generally private investment partnerships, and regulations do not allow over 100 investors in one hedge fund. This limited number of investors results in the hedge fund seeking a large minimum investment amount, and most of these funds lock in the investments for a minimum period of one year. 
  •  All sorts of investment strategies are used by hedge funds, which typically adopt an aggressive stance to manage portfolios. These strategies include leveraging, short selling, taking long positions, derivatives trading, and exposure to both domestic and foreign markets. All these strategies are aimed at generating the maximum possible returns. For example, a hedge fund may follow a strategy of short selling, meaning shares are sold without owning them with an aim to buy them back in the future at a lower price. Another hedge fund strategy is to use arbitrage where the funds seek to benefit from the difference between two related securities, such as taking a short position in a particular bond and short on the equity of underlying issuer of that bond. 
  •  One major hedging strategy of these funds involves making investments with the expectation of corporate events such as mergers, acquisitions, and de-mergers. Another good investment for hedge funds is securities trading with huge discounts, especially when they anticipate some positive developments on those securities. It is this broad range of hedge fund strategies that helps these funds generate good returns in times of both rising and falling markets. 
  •  To get hedge fund information or hedge fund guidance, you can consult various funds including the Hedge Fund Association. Unlike mutual funds, hedge funds are not required to be registered with the U.S. market regulator, the Securities and Exchange Commission (SEC), and therefore are not required to share most of their information with the public.
  • As per the SEC, hedge funds are not required to make periodic reports, but they are subject to the same prohibitions against fraud as other market participants. Their managers have the same fiduciary duties as other investment advisers.

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