If you look at the Forbes list of American Billionaire 2011 you will find 39 of them having the job in hedge fund investment, which basically draws our attention to what makes hedge fund investment so profitable and money making mechanism. For that we need to understand what hedge fund is?
INTRODUCTION
Hedge funds refer to funds that can use one or more alternative investment strategies, including hedging against market downturns, investing in asset classes such as currencies or distressed securities, and utilizing return-enhancing tools such as leverage, derivatives, and arbitrage.
At a time when world stock markets appear to have reached excessive valuations and may be due for further correction, hedge funds provide a viable alternative to investors seeking capital appreciation as well as capital preservation in bear markets. The vast majority of hedge funds make consistency of return, rather than magnitude, their primary goal.
It can be in other words explained as A fund, usually used by wealthy individuals and institutions, which is allowed to use aggressive strategies that are unavailable to mutual funds, including selling short, leverage, program trading, swaps, arbitrage, and derivatives. Hedge funds are exempt from many of the rules and regulations governing other mutual funds, which allows them to accomplish aggressive investing goals. As with traditional mutual funds, investors in hedge funds pay a management fee; however, hedge funds also collect a percentage of the profits (usually 20%).
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STRUCTURE
The portfolio is managed by the investment manager, a separate entity which is the actual business and has employees.
As well as the investment manager, the functions of a hedge fund are delegated to a number of other service providers. The most common service providers are:
Prime broker – Prime brokerage services include lending money, acting as counterparty to derivative contracts, lending securities for the purpose of short selling, trade execution, clearing and settlement. Many prime brokers also provide custody services. Prime brokers are typically parts of large investment banks.
Administrator – The administrator typically deals with the issue of shares, and performs related back office functions. In some funds, particularly in the US, some of these functions are performed by the investment manager, a practice that gives rise to a potential conflict of interest inherent in having the investment manager both determine the NAV and benefit from its increase through performance fees. Outside of the US, regulations often require this role to be taken by a third party.
Distributor – The distributor is responsible for marketing the fund to potential investors. Frequently, this role is taken by the investment manager.
Facts about hedge funds
- Estimated to be a $2 trillion industry and growing every year, with approximately 10,000 active hedge funds.
- Includes a variety of investment strategies, some of which use leverage and derivatives while others are more conservative and employ little or no leverage. Many hedge fund strategies seek to reduce market risk specifically by shorting equities or derivatives.
- Most hedge funds are highly specialized, relying on the specific expertise of the manager or management team.
- Performance of many hedge fund strategies, particularly relative value strategies, is not dependent on the direction of the bond or equity markets -- unlike conventional equity or mutual funds (unit trusts), which are generally 100% exposed to market risk.
- Many hedge fund strategies, particularly arbitrage strategies, are limited as to how much capital they can successfully employ before returns diminish. As a result, many successful hedge fund managers limit the amount of capital they will accept.
- Hedge fund managers are generally highly professional, disciplined and diligent.
- Their returns over a sustained period of time have outperformed standard equity and bond indexes with less volatility and less risk of loss than equities.
- Beyond the averages, there are some truly outstanding performers.
- Investing in hedge funds tends to be favoured by more sophisticated investors, including many Swiss and other private banks, who have lived through, and understand the consequences of, major stock market corrections. Many endowments and pension funds.
CONCLUSION
Hedge funds tackle the traditional fund sector with a strong challenge. They have attracted more attention and media interest than the traditional sector, they have drawn heavily on the pool of talented fund managers due to their lucrative compensation packages, and they have attracted a very strong (but still proportionately small) flow of capital. There is also some evidence that hedge funds have outperformed on average in terms of their risk-reward profile, although this evidence is not yet conclusive. At a minimum, hedge funds have brought innovative investment strategies and a new sense of excitement to the investment community.
