A hedge fund is a financial instrument that makes use of advanced investment strategies. ‘Hedging’ is a financial practice that helps minimise investment risk, protects capital and helps make profit from an investment. A hedge fund is a vehicle of collective investment that aims at earning positive returns on investment and consists of a vast range of trading and investment activities.
Hedge funds invest the money in different asset classes, such as commodities, foreign exchange, equities and so on. This combination and diversification helps make profit, even if the prices of certain shares or asset are falling. Hedge funds are meant for a specific group of investors, such as high net-worth individuals, corporates, investment banks, insurance companies and pension funds.
How hedge funds work
Hedge funds are open-ended funds, i.e. an investor can enter or exit the investment at any point of time, depending upon the market conditions and his risk appetite. It is believed that there are more than 8,100 hedge funds operating around the world, with asset under management (AUM) of £750 billion. Hedge funds require large sums for minimum initial investments. Around 82 per cent of the Europe’s hedge funds are based in the United Kingdom, with London as its hub. The performance of these hedge funds has a vast impact on the shares traded over the London Stock Market. The hedge funds based in UK are strictly regulated by the Financial Services Authority (FSA), which protects the interest of the investors.
The investment and trading strategies used in a hedge fund depend upon the class of investment. Strategies like leverage, derivatives, short-selling, going long or short on an asset class are used to balance the portfolio and achieve maximum returns. For example, buying an asset or a security hoping its price will increase and selling an asset, or a security if its prices are speculated to fall.
Management of hedge funds
The net asset value (NAV) of hedge funds is billions of pounds. The hedge funds are professionally managed by highly qualified and experienced Fund Managers or Portfolio Managers on behalf of the investors. These people have great expertise and in-depth knowledge of the working of the markets and their impact on investment across the various asset classes. Generally, fund managers invest their own money into the fund. This is called leveraging and it aims towards protecting the interest of the investors and maximising their returns. The Fund Managers charge management fees for their services, which is a percentage of the asset under their management.
The Fund Manager may carry out the research and analysis on his own, and take investment and trading decisions. In other cases, he may employ a staff of analysts and traders to assist him. The analysts look at past performances, assess the current scenario of economic and political environments, and forecast the future of the investment or asset class.
The traders work in real time and they execute the buy and sell orders. They need to react promptly on the market events and extract the best out of it. A Fund Manager may also use the services of an outside consultant to make appropriate investment decisions.
The Benefits of Hedge Funds
- Adding hedge funds to the portfolio of equities and bonds reduces exposure to risk, reduces volatility, and increases the chances of earning profits.
- Hedge funds are designed in such a way that it earns positive returns in both up and down market conditions.
- A wider range of asset class is available to the investor depending up on his investment objectives.
- Hedge funds offer greater flexibility and opportunities considering the fact that they are open-ended funds.
- Hedge funds are sophisticated solutions for a long-term investment and wealth creation goal.
Hedge funds are an investment option that can provide benefits for all kinds of investors, by offering a wide range of lower risk investment opportunities, helping them make the best return on their money.
This article is brought to you on behalf of Emanuel Arbib of Intergrated Asset Management – read his blog for more.
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