Economics
Hedge funds are investment funds that pool capital from accredited individuals or institutional investors and employ various strategies to generate high returns. They often use leverage and derivatives to amplify their investment positions. Unlike traditional investment funds, hedge funds are typically open to a limited number of investors and are subject to less regulatory oversight, allowing them to pursue more aggressive investment strategies.
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Financial Terms Dictionary - 100 Most Popular Financial Terms ExplainedThomas Herold(Author)
2020(Publication Date)
THOMAS HEROLD(Publisher)
...What is a Hedge Fund? A hedge fund is an investment fund which are commonly only open to a specific group of investors. These investors pay a large performance fee each year, commonly a certain percent of their funds under management, to the manager of the hedge fund. Hedge funds are very minimally regulated and are therefore are able to participate in a wide array of investments and investment strategies. Literally every single hedge fund pursues its own strategy of investing that will establish the kinds of investments that it seeks. Hedge funds commonly go for a wide range of investments in which they may buy or sell short shares and positions. Stocks, commodities, and bonds are some of these asset classes with which they work. As you would anticipate from the name, hedge funds typically try to offset some of the risks in their portfolios by employing a number of risk hedging strategies. These mostly revolve around the use of derivatives, or financial instruments with values that depend on anticipated price movements in the future of an asset to which they are linked, as well as short selling investments. Most countries only allow certain types of wealthy and professional investors to open a hedge fund account. Regulators may not heavily oversee the activities of hedge funds, but they do govern who is allowed to participate. As a result, traditional investment funds’ rules and regulations mostly do not apply to hedge funds. Actual net asset values of hedge funds often tally into the many billions of dollars. The funds’ gross assets held commonly prove to be massively higher as a result of their using leverage on their money invested. In particular niche markets like distressed debt, high yield ratings, and derivatives trading, hedge funds are the dominant players. Investors get involved in hedge funds in search of higher than normal market returns. When times are good, many hedge funds yield even twenty percent annual investment returns...
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Alternative AssetsInvestments for a Post-Crisis World
Guy Fraser-Sampson(Author)
2011(Publication Date)
Wiley(Publisher)
...The hedge fund industry continues to have much to offer the world’s investors, but if it is to have a viable and successful future then the traditional hedge fund model needs to be reconsidered, and the rival interests of investors and managers more closely aligned. Summary Hedge funds are investment vehicles which invest almost entirely in derivative instruments, or by creating derivative-type exposure by short selling. Where they do not, it is because such a methodology is not legally possible in a particular market. Unlike conventional investors, who use derivatives to hedge an underlying position or liability, hedge funds use derivatives without an underlying position or liability for purely speculative purposes. In addition to the gearing naturally provided by the derivatives themselves, many hedge funds have in the past been very highly leveraged with debt. Hedge fund trades are typically carried out in matched groups, such as pairs, and may seek to exploit perceived aberrations in pricing, or expected economic or corporate events. Strategies are called “tilts” and may be thought of as grouped loosely into three broad categories: equity based, credit based and global macro. A full list of hedge fund strategies is listed above. For the purposes of this book, we will be treating active currency separately as an asset class in its own right. Fee structures have emerged as a major issue within the hedge fund industry, with some detractors arguing that managers have charged private equity type fees for quoted equity type returns. Despite these reservations, at the time of writing, fundraising appears to be picking up once more, and inflows to existing funds currently outnumber outflows. So too has the issue of co-investor risk, which is dealt with more fully elsewhere...
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The Handbook of Traditional and Alternative Investment VehiclesInvestment Characteristics and Strategies
Mark J. P. Anson, Frank J. Fabozzi, Frank J. Jones(Authors)
2010(Publication Date)
Wiley(Publisher)
...CHAPTER 16 Introduction to Hedge Funds The phrase hedge fund is an artful term. It is not defined in the Securities Act of 1933 or the Securities Exchange Act of 1934. Additionally, “hedge fund” is not defined by the Investment Company Act of 1940, the Investment Advisers Act of 1940, the Commodity Exchange Act, or, finally, the Bank Holding Company Act. Even though the Securities and Exchange Commission (SEC) has attempted (unsuccessfully) to regulate hedge funds, it has yet to define the term “hedge fund” within its security regulations. So what is this investment vehicle that every investor seems to know but for which there is scant regulatory guidance? As a starting point, we turn to the American Heritage Dictionary, 3rd edition, which defines a hedge fund as: “An investment company that uses high-risk techniques, such as borrowing money and selling short, in an effort to make extraordinary capital gains.” This is a good start; however, many hedge fund strategies use tightly controlled, low-risk strategies to produce consistent but conservative rates of return and do not “swing for the fences” to earn extraordinary gains. We define hedge fund as a privately organized investment vehicle that manages a concentrated portfolio of public and private securities and derivative instruments on those securities, that can invest both long and short and can apply leverage. In this chapter, we discuss the various types of hedge funds according to the investment strategies that they pursue. In the next chapter, we focus on considerations in investing in hedge funds. HEDGE FUNDS VS. MUTUAL FUNDS Within this definition there are six key elements of hedge funds that distinguish them from their more traditional counterpart, the mutual fund. First, hedge funds are private investment vehicles that pool the resources of sophisticated investors...
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The Handbook of Financial InstrumentsFrank J. Fabozzi, Frank J. Fabozzi(Authors)
2018(Publication Date)
Wiley(Publisher)
...These strategies tend to focus on only one sector of the economy or one segment of the market. They can tailor their portfolio to extract the most value from their smaller investment sector or segment. Third, hedge funds tend to use derivative strategies much more predominately than mutual funds. Indeed, in some strategies, such as convertible arbitrage, the ability to sell or buy options is a key component of executing the arbitrage. The use of derivative strategies may result in non-linear cash flows that may require more sophisticated risk management techniques to control these risks. Fourth, hedge funds may go both long and short securities. The ability to short public securities and derivative instruments is one of the key distinctions between hedge funds and traditional money managers. Hedge fund managers incorporate their ability to short securities explicitly into their investment strategies. For example, equity long/short hedge funds tend to buy and sell securities within the same industry to maximize their return but also to control their risk. This is very different from traditional money managers that are tied to a long-only securities benchmark. Finally, hedge funds use leverage, sometimes, large amounts. Mutual funds, for example, are limited in the amount of leverage they can employ; they may borrow up to 33% of their net asset base. Hedge funds do not have this restriction. Consequently, it is not unusual to see some hedge fund strategies that employ leverage up to 10 times their net asset base. We can see that hedge funds are different than traditional long-only investment managers. We next discuss the history of the hedge fund development. HEDGE FUND REGULATION Hedge funds are often referred to as “unregulated” investment vehicles—investment funds that manage to stay outside the reach of the securities laws. The fact is that hedge fund managers take advantage of ready-made exemptions that are part of the securities laws themselves...
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Canadian Securities Exam Fast-Track Study GuideW. Sean Cleary(Author)
2017(Publication Date)
Wiley(Publisher)
...Chapter 21 HEDGE FUNDS CSC EXAM SUGGESTED GUIDELINES: 9 questions combined for Chapters 20 and 21 OVERVIEW OF HEDGE FUNDS ! Hedge funds are pools of capital that face light regulation and whose managers have significant flexibility in managing their assets. They are permitted to use derivatives for leverage or speculation, assume short positions, and do several other things that are not permitted for traditional mutual fund managers. Hedge funds are often referred to as alternative investment strategies to reflect this investing flexibility, although investments in real estate, private equity, and commodities/managed futures are also considered alternative strategies. ! Hedge funds share some similarities with mutual funds, but they differ in many ways, as shown in the table below: Mutual Funds Hedge Funds pooled investments with sales charges same sold by investment dealers same charge management fees same very limited short positions no short position restriction derivative use limited no limits on derivative use usually liquid may have liquidity restriction sold through prospectus sold through offering memorandum to sophisticated or accredited investors only usually no performance fees usually performance fees relative return objective (vs. benchmark) absolute return objective most valued daily most valued monthly quarterly or annual disclosures annual disclosures to unit holders cannot assume concentrated positions in securities can assume concentrated positions Eligible hedge fund investors include the following: ! High-Net-Worth and Institutional Investors : Usually funds targeted to this audience are structured as limited partnerships and are sold as private placements through “offering memorandums” rather than through prospectuses. Offering memorandums are legal documents that state the objectives, risks, and terms of investments, but are not required to provide as much information as prospectuses (although some may)...
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Portfolio DesignA Modern Approach to Asset Allocation
Richard C. Marston(Author)
2011(Publication Date)
Wiley(Publisher)
...Chapter 9 Hedge Funds Hedge funds are difficult to define if only because they have morphed into so many different shapes. The term hedge used to mean that the funds attempted to hedge one set of assets with another. This was certainly true of the first hedge fund formed in 1949 by A.W. Jones, and is still true of hedge funds following market-neutral strategies (as explained later). But many hedge funds have directional strategies that are anything but hedged. Perhaps it’s better to define hedge funds by the fees they charge. The Investment Company Act of 1940 insists that a Registered Investment Company (RIC) like a mutual fund charge symmetrical investment fees. So their fees remain fixed in percentage terms whether the fund rises or falls. Hedge fund managers insist on asymmetrical fees typically consisting of a management fee paid regardless of performance and an incentive fee charged as a percentage of the upside. A typical fee schedule would be to charge a 1 percent or 2 percent management fee on all of the assets under management and a 20 percent incentive fee. 1 To avoid having to register as an RIC, the hedge fund must be offered to investors only through a private placement. Hedge funds are organized as partnerships with the general partners being the managers and the limited partners being the investors. The form of the partnership is similar to that used by private equity and venture capital firms. In fact, these firms also charge asymmetrical investment fees. So how are hedge funds different from private equity and venture capital firms? The answer is that their investment horizons and their investments are very different. Hedge funds have short-term strategies and typically invest in publicly available securities such as equities and bonds. Private equity and venture capital invest for extended periods in firms and they invest in projects not generally available to the general public...
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Investment Banks, Hedge Funds, and Private EquityDavid P. Stowell(Author)
2012(Publication Date)
Academic Press(Publisher)
...11 Overview of Hedge Funds In the United States, the Securities and Exchange Commission (SEC) has stated that the term hedge fund “has no precise legal or universally accepted definition.” 1 But most market participants agree that hedge funds have the following characteristics: (1) almost complete flexibility in relation to investments, including both long and short positions; (2) ability to borrow money (and further increase leverage through derivatives) in an effort to enhance returns; (3) minimal regulation; (4) somewhat illiquid since an investor’s ability to get their money back is restricted through lock-up agreements (that may prevent any liquidity during the first one or two years of a hedge fund’s life) and quarterly disbursem*nt limitations thereafter (subject to “gates” that may further limit disbursem*nts); (5) investors include only wealthy individuals and institutions such as university endowments, pension funds, and other qualified institutional buyers (except for fund of fund investments, which are available to a broader array of investors); and (6) fees that reward managers for performance, as described in the following. A typical fee structure for hedge funds includes both a management fee and a performance fee, whereas a typical mutual fund does not require a performance fee, and has a smaller management fee. Hedge fund management fees are usually around 2% of net asset value (NAV) and performance fees are approximately 20% of the increase in the fund’s NAV. This “2 and 20” fee structure is significantly higher than for most other money managers, with the exception of private equity fund managers, who enjoy similarly high fees. Hedge funds target “absolute returns,” which are investment returns that theoretically don’t depend on the performance of broad markets and the economy, unlike the returns associated with mutual funds...
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The Long and Short Of Hedge FundsA Complete Guide to Hedge Fund Evaluation and Investing
Daniel A. Strachman(Author)
2008(Publication Date)
Wiley(Publisher)
...The concept was selling something that was too good to be true and ripping them off with each and every sale. They were not only get rich quick artists but they played on individuals’ patriotism, lust of money, greed, and desires. The roots of hedge funds of funds date back to the 1970s; however, the industry really began to grow in the wake of the October 1987 crash of the stock market. The stock market turmoil of the late 1980s prompted investors to demand greater access to hedge funds, and, in turn, access to hedge fund managers. Within the past decade, a large number of organizations have gotten out in front of the fund of funds industry and have built fantastically successful businesses. The premise for each and every one of these firms is that investors, particularly institutional investors, shun the responsibility that comes with allocating assets directly to hedge funds because there is potentially too much risk in allocating to a single manager. Funds of hedge funds provide cover for their institutional rear-ends. Assessing risk is hard work. Performing due diligence isn’t much easier. Naturally, most people want to avoid taking the blame for an investment gone bad. Funds of hedge funds solve both problems—the investor gets someone both to do the due diligence and to take the rap if things don’t go well. Again, it’s simple, elegant—and very attractive to many investors. HOW A FUND OF FUNDS WORKS Here’s how it works: Clients invest their money in one fund. Its manager takes those assets, combines them with other investors’ assets, and spreads them among a number of hedge funds. This solves two other problems for the investor, as well: how to diversify assets through a single entry point, and how to gain access to multiple managers, regardless of how little money you are able to put to work. The fund of funds industry has grown significantly over the last few years...
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