Hedge funds are an alternative method of investing. It is a form of investment where funds are pooled and invested using different investment strategies to generate profits in a financial partnership between the fund manager and the investors.
The fund manager is called general partner and the investors are called limited partners. The role of the limited partners is to invest the funds and that of the general partner is to manage them. Investors receive a cover prospectus which provides information on key aspects of the fund, such as the fund’s investment strategy, type of investment and leverage limit.
As their name suggests, hedge funds work to “hedge” or avoid risk. Thus, we see that the objective of hedge funds is profit maximization as well as risk minimization. They are intended to generate profits regardless of market fluctuations. They minimize risk by offering investors to buy stocks long or short. Short selling involves making money when the stock goes down.
An investment manager manages funds through a separate company from the hedge fund and its portfolio of assets. The investment manager uses the support of the following service providers:
They help with trade clearing, provide leverage and short-term funding.
They provide operations, accounting and valuation services.
They essentially deal with the distribution of securities. A distributor can be an underwriter, a trader or a broker.
The investment strategies adopted can be classified as follows:
• Discretionary/Qualitative: These are strategies chosen by the general partner or the fund manager.
• Systematic/Quantitative: These are strategies suggested by a computerized system.
Characteristics of hedge funds:
• Available only to accredited investors
Investors must have a certain net worth before investing in hedge funds.
• Variety of investment options
It can be invested in various fields such as land, real estate, stocks, derivatives, currencies, etc.
• Use leverage
Borrowed money is often used to improve returns.
They charge management fees and performance fees.
The main advantage of investing in hedge funds is that the risk is lower than other types of investments. We can say that they are not correlated with market indices. However, the fact remains that they are subject to a certain amount of risk. Therefore, it is a good approach to be aware of all potential risks before investing. It is also essential to select a fund manager experienced in the field.
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