Hedge funds

Abstract

A hedge fund is an aggressively managed portfolio of investments that uses advanced investment strategies such as leverage, 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). Hedge funds may be characterized as private investment programs where the manager seeks positive returns by exploiting investment opportunities, while protecting principal from financial loss. Hedge funds are quite diverse, as several strategies and techniques can be employed to attain the same investment objectives. Consequently, hedge funds are synonymouswith the term "alternative investment strategies." Some hedge funds follow very conservative strategies while others are more aggressive. 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 1 year. For the most part, hedge funds (unlike mutual funds) are unregulated because they cater to sophisticated investors. In the United States, laws require that the majority of investors in the fund be accredited. That is, they must earn a minimum amount of money annually and have a net worth of more than $1 million, along with a significant amount of investment knowledge. You can think of hedge funds as mutual funds for the rich. They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more flexibility in its investment strategies. The term "hedge funds" is often times a misnomer as some funds may not hedge their underlying positions. It is important to note that hedging is actually the practice of attempting to reduce risk, but the goal of most hedge funds is to maximize return on investment. The name is mostly historical, as the first hedge funds tried to hedge against the downside risk of a bear market by shorting the market (mutual funds generally cant enter into short positions as one of their primary goals). Nowadays, hedge funds use dozens of different strategies, so it isnt accurate to say that hedge funds just "hedge risk." In fact, because hedge fund managers make speculative investments, these funds can carry more risk than the overall market.1. © 2009 Springer-Verlag Berlin Heidelberg.