— CFA Institute® (@CFAinstitute) March 22, 2017
On hedge funds: "well, if you want to get poor quickly…"
— Phil Huber CFA, CFP® (@bpsandpieces) June 13, 2017
So what are Hedge funds and why there is always someone talking about them, whether good or bad?
Traditional asset classes like Stocks, Bonds or cash having some limitations. You cant go short on Bonds for a long period of time. You either hold them or sell them if you are bearish them. So either you will make money on them by holding them or you can sell them. There is no other way. But when the price of one bond is going down, it means something. For earning a return on that downside or hedging the position you need something. Alternative investments are exactly what it is. The word Alternative in the name of the securities does not mean that they are uncommon and/or relatively recent additions to the investment universe.
In 1949, Alfred Winslow Jones, a sociologist investigating fundamental and technical research to forecast the stock market for Fortune magazine, set up an investment fund with himself as GP. The fund followed three key tenets:
- Always maintain short positions
- Always use leverage
- Charge only an incentive fee of 20% of profits with no fixed fees.
Jones called his portfolio a “hedged” fund (eventually shortened to “hedge fund”) because he had short positions to offset his long positions in the stock market. Theoretically, the overall portfolio was hedged against major market moves.
You can compare hedge funds with Mutual Funds but with some small Difference. Both of them having fund managers. Both of them have assets under management. But Hedge funds will get TWO types of fees from you. Return on the Mutual fund will not differ largely with respect to returns from markets. In Mutual funds, the Fund manager may or may not be invested his own Fund but In Hedge funds, He is General Partner. Mutual Funds may or may not hold the Leveraged position. Debt mutual funds don’t have permission to Hold equity position. Hedge funds can do such things. Ther is nothing called as Hurdle rate or High water mark ( reflect the highest cumulative return used to calculate an incentive fee. It is the highest value, net of fees, that the fund has reached. The use of high-water marks protects clients from paying twice for the same performance) in mutual Funds but in Hedge funds, it is there.
Many investors interested to invest in hedge funds all because of The diversification they are giving to you. In technical language, Coefficient of return of hedge funds and traditional asset classes are making an opportunity to diversify and protect your portfolio from the downside of the market. But the thing is that Investor cant decides he wants to invest in hedge funds. It’s fund who will decide who is eligible to invest with it.
Hedge fund managers are less restricted than traditional investment managers and thus may have the flexibility to invest anywhere they see opportunity. Most hedge funds do have a broadly stated strategy but are allowed some deviation from that strategy. Hedge funds are often given the flexibility to invest a percentage of the AUM, generally less than 20%, how and when they see fit.
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