Hedge
Fund Basics
Author:
Dave Inglis (Part 2 of 3)
WHAT
IS A HEDGE FUND?
A
hedge fund is a private investment partnership run by a money manager who
has his own money in the fund. The private aspect of the pooled fund gives
the manager more leeway in the securities and the strategies used compared
to traditional mutual or segregated fund managers. Hedge funds are usually
known for their superior returns.
WHY
SHOULD I INVEST IN HEDGE FUNDS?
Hedge
funds have generally outperformed all other asset classes. Good hedge funds
could generally provide greater diversification, lower volatility, neutral
market correlation, risk management, capital protection and appreciation,
and greater returns than traditional investments.
WHY
ARE THEY CALLED HEDGE FUNDS?
The
term hedge fund is actually a misnomer because most of them do not even hedge
their positions. The word was first used in the 1940s when Mr. Alfred Jones
created the first fund combined of long and short positions. Since that time,
private investment vehicles have evolved into a more heterogeneous group
of money managers using more complex strategies and offering a greater array
of products. Most of these funds might not hedge their positions but the
catchy name stayed.
WHAT
STRATEGIES DO THEY USE?
Hedge
funds are managed by sophisticated money managers who use a great array of
strategies. Nothing is left unused. They can use anything from complex arbitrage
strategies to simple long positions. Some funds specialize in very distinctive
strategies where others may combine more than one strategy. Most use leverage
and many may have short positions in their portfolio. For more information
on specific Hedge Fund strategies, see the document entitled "Common
Hedge Fund Strategies".
HOW
LARGE IS THE INDUSTRY?
The
census of private investment is never easy to do but it is known to represent
approximately 500 to 600 billion $US. Hedge fund services generally track
between 3,000 to 4,000 funds, but it said that there might be up to 6,000
funds in the world. The hedge fund industry is relatively small in comparison
to the mutual fund or the bond industry, but it is growing rapidly at an
estimated rate of 27% per year.
WHAT IS A FUND OF FUNDS?
A
"Fund of Funds" is simply an investment vehicle that invests in
other hedge funds. By creating a pool of single strategies, the fund of funds
manager can create a more diversified fund. By nature, the fund of funds
manager will not make direct decisions on investments within each underlying
fund, but instead uses expertise in risk management, market direction and
investment strategies to decide the composition and direction of his/her
particular fund of funds. Using this knowledge and expertise, the fund of
funds manager can create a fund that will have very little correlation with
other assets, will greatly outperform in all market conditions and will experience
lower volatility.
Through
a limited partnership, private investors and institutional groups can
have access to the best hedge fund managers by styles with daily risk
management and a wealth of knowledge from the fund of funds' investment
decision team. To the investor, this allows participation in a unique
allocation process that could limit some of the downside risks without
having to constantly monitor the single managers or having to go through
the continuous process of due diligence.
Part 1 of 3 >
Part 2 of 3 > Part 3
of 3
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