Determining What is Hedge Fund
In a global economy that had its ups and downs in 2011, hedge funds
enjoyed more ups than downs. As of early 2011, over 225 hedge funds
managed more than a billion dollars each, and collectively the 225
funds managed around 1.3 trillion. This financial prosperity in
difficult economic times has led many to begin asking the question:
what is hedge fund?
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In some ways, hedge funds are very similar to mutual funds. In both
types of funds, investors provide the money that a fund manager uses
to invest in stocks, bonds, and other securities. The investors then
reap the benefits when those securities increase in value, and reduce
their own risk by diversifying their investments. Despite the
similarities, there are very distinct differences that allow one to
determine what is hedge fund and what is a mutual fund.
The management of hedge funds, unlike that of mutual funds, was not, until recently,
overseen by the Securities and Exchange Commission (SEC). Also, because most hedge funds are private investment partnerships, investment in hedge funds is not open to the general public.
Instead it is restricted to accredited investors, a group that
includes wealthy individuals as well as institutions like banks, pensions, insurance companies, and
some corporations (among other entities). In short, accredited
investors are those that can handle high risk investments, thus are
able to invest in hedge funds.
Another consequence of being organized as private investment partnerships is that hedge
funds cannot market themselves to the general public. Thus, while it is common to see mutual
funds advertised in magazines and newspapers, hedge funds go
relatively under the radar. Even the largest hedge funds in the world
may be unheard of by the typical investor.
If you examine what is a hedge fund based on investment strategies, it
can be seen that hedge funds have a more diverse investment strategy
than practiced with mutual funds. Hedge funds invest in
liquid and illiquid securities, and use methods like short selling and leverage or
gearing, which are not generally utilized by mutual funds. Short
selling involves selling borrowed securities with the intention of
buying them back for a lower price at a later date. This is done when it is believed
their value will fall, and thus the fund will be able to buy them back
for less than the price at they they sold short. Leverage is simply a way to increase
gains. It is often accomplished by hedge funds by providing money as
collateral to cover credit risk.
Another unique factor to consider when considering hedge fund investments is
that hedge fund managers often receive a portion of the profit made by
the fund. This is not the case with mutual funds, as mutual fund
managers receive a percentage of the assets without regard to the
fund's performance. Hedge funds are more actively managed, and the
management company frequently receives around 20% of the profits of
the fund. The management fee alone for hedge funds, around 2%, is also
typically higher than the fee for mutual funds (around 1%).
Here is an example of a very good Hedge Fund Database.
Hedge funds are a very unique investment. They have several features
that make them different from other collective investments like mutual
funds. Thus, when attempting to determine what is hedge fund, keep the
above information in mind.