A hedge fund refers to a type of fund that is strictly limited to a certain type of investor, generally only those that have a certain amount of capital and are accredited. As a result of the lack of regulation of hedge funds, they can be used to facilitate a greater range of trading strategies than what you could do with a conventional investment.
As a type of investment, such funds are able to invest in a lot of different asset types, such as commodity futures, stocks and forex.
When they first came into the public eye, ‘hedge fund’ was a description for a type of fund that would attempt to hedge the exposure of their investments, helping to mitigate portfolio risk. In order to achieve this, they would take advantage of both options and short selling. As the industry has matured, however, the term now broadly pertains to any fund that attempts to produce returns that aren’t correlated to the major indices. Quite simply, this means that hedge funds aren’t majored against indexes, and use market timing strategies to produce alpha, which is their value above the index..
The fees that hedge funds charged, however, are often quite a bit different than what you will find with mutual funds. The majority of fund managers base their fees around management and performance fees, often on a 2 and 20 basis. The 2 represents a 2% annual management fee, and the 20 is for a 20% performance fee, that is charged on all net performance gains. This is calculated through the use of a high watermark, which is the highest point that any given account has reached.
Over the last ten years, hedge funds have grown considerably. By the summer of 2008, it was speculated that hedge funds now comprise a total of 2.5 trillion dollars, but this has obviously declined somewhat in the wake of the financial crisis.
As an investor, there are many things to look into before allocating to a hedge fund, such as the investment strategies that the fund offers, lockup limitations, any fees, and the liquidity of the market.
Despite all of the negative news headlines over the recent months, hedge funds are still a very suitable investment for many people. You just have to make sure that you do your due diligence, and that you are investing in a strategy that is broadly robust, rather than one that is likely subject to fail when the market goes through sudden changes.