What is a hedge fund
WHAT IS A HEDGE FUND?
An aggressively managed portfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark). Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment. Investments in hedge funds are illiquid as they often require investors keep their money in the fund for at least one year. (this excerpt was taken from investopedia)
OK- so now that we have the bulk of the technical meaning down thanks to investopedia, now is where the real work begins. I for one grew up in Greenwich Connecticut and have always wanted to learn this industry, so here I sit to help you understand this market as I search the net to understand it as well. The best place to start with is always at the beginning. What is a Hedge Fund, and how did it get its name?
in 1949 a gentleman by the name of Alfred W. Jones started the first fund. At the time he was a financial journalist, and through some research and personal investments he noticed there might be a way to cap losses or exceed expectations in his portfolio. He found this by buying assets he felt would be stronger then the market (buying something far below what he believed the real cost would be in the near future) and selling short assets he believed would be weaker.
Because he was able to see the benefits of “hedging” his risk, (where if one asset went down the flip side would be the gain the other assets had) he was able to balance his portfolio and the risk associated with it. This practice became what is known as a Hedge fund.
Now that we have the short history on what a hedge fund is and how it came about, lets talk “lingo”. One large aspect of this market that confuses me is all the terms used. Lets hit key terms to help unravel their meaning and what they mean to an investor or the person you are investing with. We will start from the most basic and work our way up to those crazy words only industry people truly understand. (until now)
Hedge Fund -
This is an investment fund offered to a select group of people for a period of time. Each fund or investment group asks for a very large amount of investment capital as a requirement. Some funds are offered at $250k and others can exceed $9million for potential investors.
Hedge Fund Manager -
An individual who manages the portfolio of the fund. He/She chooses what assets to buy and sell to hedge against the market so that the selected investors make a solid return over the course of a specified amount of time.
Hedging – (also known as Long/short equity)
To buy and sell assets on both ends of the spectrum.
1. to purchase an asset below market value when you believe the market value will far exceed market potential.
2. to short sell assets when you believe the market value will depreciate.
in essence what your doing is trying to create a happy medium to where your investments won’t fluctuate in any given market, and if they do it is with great outcomes .
Assets -
Assets are things of value that can be readily converted into cash. for example, securities, funds, property and land.
Securities -
Is debt that represents a financial value that can be negotiated. Most securities are presented in two ways, either by a certificate which states your rights or privileges to the security by being the holder of it, or by electronic submission where your information is placed in a registry maintained by the securities issuer. (for example: banknotes, bonds and debentures)
Funds -
A set of asset investment actions joined together for a long or short term goal.
Fund of Funds (FoF) -
Instead of investing in other securities, Funds of Funds holds portfolios of other funds to manage. For example mutual fund‘ FoF, hedge fund FoF, private equity FoF or investment trust FoF are categories that can be found in this arena.
Collective investment scheme -
Investing money in a wider range of investments that’s typically not feasible for one individual to partake in. As a group you all share in the cost and benefits of the investment.
Management Fees -
The fee a manager takes as a part of his compensation for investing your money. Usually this fee is between 1-2% paid as a yearly stipend yet calculated and distributed to the manager monthly or quarterly.
Performance Fees -
Typically this fee is used to pay the overhead for the manager and staff income along with bonuses. This fee is taken at the end of the invested term and usually is stipulated to be between 15-20% of the total profits the hedge fund made. Some managers also have their fees stipulated in this area since its incentivising them to perform.
High-Water Marks -
Since a manager only benefits on the positive profits of the fund he/she never takes losses. Many would stipulate if they have to take a loss then so should the manager. This is where high-water marks come to play. A manager will only see a profit on the increase of Net Asset Value at its highest mark, and will only see a performance fee each time he/she performs greater then the highest value. So if a share is $100 and after year one its at $120 then the fee would be $20. If the value takes a hit and drops to $110 there will be no fee paid, but should the value climb to $130 then the fee would be $10 as it made a gain from that last highest value of $120.
Hurdle Rates –
This is a marketing tool that helps investors feel confident in the performance of a manager. The manager stipulates he/she will only obtain a fee if they are able to get the fund over a certain % (hurdle). If the manager states he/she can net a return of 5% then he/she would realize their fees once that return has been made.
Withdrawal / Redemption Fee -
Usually put in place to make sure no withdrawals are made within the first year of investing to dissuade short term investors. With more money in the fund at a longer rate the manager can implement longer investment schemes to help the performance of the fund. If the fund is performing less then perfect this fee is also set up to dissuade investors from pulling out. Unlike the other Fees that benefit the manager these fees only benefit the other pool of investors still in the fund.
Emerging Markets -
Nations with rapid growth. It is noted in Wikipidia that there are currently 28 with the top two as China and India.
Sector Funds -
is just another word for niche funds that specialize in areas such as minerals, technology, pharmaceuticals ect.
Multi-Strategy -
This is what managers employ to gain more diversification in a portfolio of investments.
Distressed Securities -
specialized in companies trading at discounts to their value because of (potential) bankruptcy. (wikipidia)
Merger Arbitrage -
This is where a manager can exploit the difference between merging companies. They can buy the stock of one knowing that the price of the other will inflate or vice-versa.
Credit Arbitrage -
corporate fixed income securities- which is corporate debt that will achieve a fixed rate of return or a regular rate of return on the investment. For example a company takes out a loan, in the loan agreement they have to pay back the loan with 10% interest. That interest rate is the fixed income/regular rate of return (until that debt is paid).
Convertible Arbitrage -
Here is when you can exploit the difference in value when something can be converted like a bond into equity but only when certain terms are in place.
Fixed Income Arbitrage -
Being able to capitalize off the difference of fixed income securities within related securities.
Regulatory Arbitrage -
The ability to take advantage of two or more regulatory markets.
Equity Market Neutral -
This is the actions taken to help your portfolio stay neutral by having both long and short term positions balance out.
Asset-backed Securities -
Assets for one reason or another that can not be sold separately. Those assets get pooled together and sold to investors.
130-30 Funds -
This is an unhedged equity fund that has 100% exposure. 130% is for long positions, and 30% is for short.
(above was just the beginning of this list of terms used in the Hedge Fund market. If you would like to submit a term with the correct meaning in words that are understandable to everyone in or outside of the market please email me.)
HEDGE FUND 101
I have read on countless websites that the investor MUST complete Due Diligence prior to investing with a hedge fund to make sure the Manager and his/her staff are both well equipped and knowledgeable in what they are doing, also to make sure it is 100% legit. With billions of dollars out in the markets its very easy to fall victim to an investment scheme that was a complete lie. This is easy to see, just take a look at Bernie Madoff a man who revolutionized aspects of Wall Street.
So, what I have gathered is this, a simplistic way to understand what a hedge fund is. A hedge fund is a way of investing in securities. There are many “schemes” or ways managers go about investing your money to make sure you achieve some type of return on the monies you have invested with them. A hedge fund manager completes this task for a selected amount of investors for either a fee on the performance or a small percentage of the portfolio or both.
Each investment period is no less then one year, if for some reason you as an investor would like to withdraw your investment prior to the first year, there are measures put into place that will dissuade you from doing so. These measures are in place to help the other investors who are still in the scheme, and it also helps the manager employ other strategies to ensure a longer and better outcome for the investors. Typically the longer the investments are managed the better the outcome. This is not always true, but it does give the Manager of the fund time to create indices and schemes to help gain a better more favorable outcome to his/her investors.
The cost to get into a hedge fund is a bit pricey for most as the starting capital needed is $25ok for some of the lower end funds. Each Fund only takes on a predetermined amount of investors at a time. For the worlds top firms they are achieving 40% returns for their pool of investors, but a typical return should be between 10-25%. If anyone says they can offer you 100% return on your investment, they are only using hypothetical equations while looking at the over all history of what scheme they want to employ. Do not fall for this type persuasion as its not realistic.
If you have the money to invest and your looking for a great return on your investment then take your time and research as much as you can about the company, the managers and the staff! Ask other people who are in the field already, look for friends and family and see what they have to say, also jump in the net and see what you can find out. There is a great deal of information out there but its up to you to find what makes the most sense to you.
I hope I was able to give you a better understanding of what a Hedge Fund is. Remember this posting was just to give you a better simplistic way of understanding this market. I’m just a guy who lives in the town known to be the capital of the hedge fund market, so if you have found this post or any other post on this blog to be helpful please help us by donating. I hope to be in a position one day to invest in these types of vehicles.
Thank you,
