Hedge Fund is: Definition, History and Advantages

Hedge funds are investments that are considered a risky alternative option. Read more hedge fund articles below!

What is Hedge Fund?

A hedge fund is a private investor limited partnership whose money is managed by a professional fund manager who uses a variety of strategies, including leveraging or trading non-traditional assets, to earn above-average investment returns. Hedge fund investments are often considered a risky alternative investment option and usually require a minimum investment or high net worth, often targeting wealthy clients. The term "hedge fund" can be interpreted as a hedge fund, the term can define this investment instrument as a fund manager who often makes hedge bets by investing a portion of the asset in the opposite direction of the fund's focus to offset losses in its core holdings. hedge fund merupakan

History of Hedge Funds

It started with a sociologist, Alfred W. Jones, who was credited with coining the phrase "Hedge Fund" and was credited with creating the first hedge fund structure in 1949. Jones referred to his funds as "hedging", a term commonly used on Wall Street to describe the handling of investment risk due to financial market transformation. In the 1970s, hedge funds specialized in a single strategy with the fund manager predominantly adhering to a long or short equity model. Many hedge funds were locked up during the recession of 1969-1970 and the stock market in 1973-1974 collapsed due to huge losses. They gained attention again in the late 1980s. During the 1990s, the number of hedge funds increased substantially with stock market gains in the 1990s, balanced interest compensation structures (mutual financial interests), and the promise of above-average recovery as well as possible causes. Over the next decade, hedge fund strategies expanded to include credit arbitrage, distressed debt, fixed income, quantitative, and multi-strategy. U.S. institutional investors, such as pension funds and endowment funds, are starting to distribute a sizable portion of their portfolios to hedge funds. During the first decade of the 21st century, hedge funds gained worldwide fame, and in 2008, the worldwide hedge fund industry held US$1.93 trillion in assets under management. However, the money crisis in 2007-2008 brought the impact of many hedge funds to limit the withdrawal of investors and their popularity and total assets under management (AUM) declined. Total AUM rebounded and as of April 2011 was estimated at nearly $2 trillion. As of February 2011, 61% of worldwide investment in hedge funds came from institutional sources.

Mutual Fund vs Hedge Fund

Hedge funds are different from mutual funds and hedge funds are not as strictly regulated by the Securities and Exchange Commission (SEC) as mutual funds. Mutual funds are a practical, cost-effective way to build a diversified portfolio of stocks, bonds, or short-term investments and are available to the general public and the average investor. Hedge funds can only accept money from accredited investors that include individuals with annual income exceeding $200,000 or net worth exceeding $1 million, excluding their primary residence. These investors are considered suitable to handle the potential risks that hedge funds are allowed to take. Hedge funds can invest in land, real estate, stocks, derivatives, and currencies while mutual funds use stocks or bonds as their instruments for long-term investment strategies. Unlike mutual funds where investors can choose to sell shares at any time, hedge funds typically limit the opportunity to redeem shares and often impose a one-year lock-in period before shares can be cashed out. Hedge funds use a 2% management fee and a 20% performance fee structure. In 2021, the average expense ratio across all mutual funds and exchange-traded funds was 0.40% for the average investor.

The characteristics of a Hedge Fund are

To find out more about hedge funds, you can read some of the characteristics below:

Accredited or Qualified Investor

Hedge fund investors must meet certain net worth requirements. Generally, a net worth exceeds $1 million or an annual income of more than $200,000 over the previous two years.

Frequent Hiring of Leverage

Hedge funds often use leverage or borrowed money to amplify their returns, potentially exposing them to much broader investment risk as demonstrated during the Great Recession. In the subprime crisis, hedge funds have been hit hard due to increased exposure to collateralized debt obligations and high levels of leverage.

Wider Investment Latitude

The world of hedge fund investment is limited only by its mandate. Hedge funds can invest in any land, real estate, derivatives, currencies, and other alternative assets. Mutual funds, on the other hand, usually have to stick to stocks or bonds.

Fee Structure

Hedge funds charge a ratio of fees and performance expenses. The general fee structure is known as two and twenty (2 and 20) asset management fees of 2% and a 20% cut of profits generated. There are more specific characteristics that define hedge funds, but because they are private investment vehicles that only allow the wealthy to invest, hedge funds can do what they want as long as they disclose the strategy upfront to investors. This wide latitude may sound very risky, and it certainly can. Some of the most spectacular financial booms involve hedge funds. That said, the flexibility provided to hedge funds has led some of the most talented money managers to generate some incredible long-term returns.

The Advantages and Disadvantages of Hedge Funds are

As an investment instrument, hedge funds have the following advantages, among others.

1. Flexible

Hedge funds are flexible investment instruments. Some investors even consider this investment to be more flexible than Mutual Funds. This is because hedge funds are not traded publicly so the legal rules are also relatively looser. In addition, this investment is also flexible because it is suitable for both short-term and long-term investments.

2. Diverse Forms of Investment

The forms of investment from hedge funds vary from stocks, bonds, property, currencies, and so on. To increase the potential for profit, these investments often use loan funds.

3. Relatively High Profit and Low Risk

Hedge funds offer relatively high returns. In addition, this investment instrument is also considered to be able to reduce the exposure to risk of losses that may arise. The reduction in the risk of this loss can even be up to 50 percent. This can have an impact on a lower level of downside volatility compared to other financial assets in general such as equities.

4. Aggressive Investment Strategy

Hedge funds have an aggressive investment strategy supported by mature portfolio diversification. This is because hedge funds are able to reduce the risk of losses in investments.

How Hedge Funds Work

Hedge funds limit their participants to accredited investors. An accredited investor is defined as someone with a liquid net worth of more than $1 million or an annual net income of more than $200,000 (or $300,000 with a spouse). The SEC allows accredited investors to invest in underregulated securities offerings because it assumes investors with that much wealth will have a level of financial sophistication. Hedge funds are structured as limited partnerships. Investors are limited partners while hedge fund companies are general partners. The hedge fund collects money from its limited partners and invests it on their behalf. Limiting itself to accredited investors allows hedge funds to take a more aggressive approach to investing because they are not as strictly regulated by the SEC as mutual funds. Managers often use advanced strategies, including leverage, short positions, and derivatives such as options, and they can invest in a variety of markets, including stocks, bonds, commodities, real estate, cryptocurrencies, and more. Almost every opportunity to make money is on the table. Investments in hedge funds are often relatively illiquid. You can only buy or withdraw during a certain period, and there is often a lock-up period of a few months to a few years after the initial investment. Operating in this manner allows fund managers to take more aggressive positions without the need to provide liquidity to investors at all times.

Examples of Hedge Funds

In 2022, the most well-known hedge funds include:

Elliot Management Corporation with a history of 55 years and more than $50 billion in assets under management (AUM). Its core ownership is in the energy sector.
Bridgewater Associates is a global leader, with AUM assets of over $235 billion, and a return rate of 32% for the first half of 2022.
Man Group offers a mix of long/short equity funds, private market funds, real estate funds, multi-asset funds, and fixed funds and its core value is responsible investing, which is achieved through the compliance of its funds with environmental, social, and governance ESG investment objectives.

Tips for Starting a Hedge Fund

What should I know if I'm considering investing in hedge funds?

Be an accredited investor. You generally need to be an accredited investor, which means having a minimum level of income or assets, to invest in hedge funds.
Read the mutual fund prospectus and related materials. Make sure you understand the level of risk involved in the fund's investment strategy, and that the risk is consistent with your personal investment objectives, time horizon, and risk tolerance. As with any investment, the higher the potential return, the higher the risk you will have to bear.
Understand how fund assets are valued. Hedge funds may hold investments that are difficult to sell and may be difficult to value. You must understand the valuation process and know the extent to which the fund's ownership is valued by an independent source.
Understand the cost. Costs affect your return on investment. Hedge funds typically charge an asset management fee of 1-2% of the asset, plus a "performance fee" of 20% of the hedge fund's profits. Performance costs can motivate hedge fund managers to take on greater risks in the hopes of generating greater returns.
Understand any restrictions on your right to redeem your shares. Hedge funds typically limit the opportunity to redeem, or cash out, your shares, to four times a year or less, and often impose a "lock-in" period of one year or more, during which you cannot cash out your shares.
Research hedge fund managers. Make sure hedge fund managers are qualified to manage your money, and find out if they have a history of discipline in the securities industry.
You can obtain this information by reviewing the advisor's ADV Form, which is an investment advisor's registration form. You can search and view a company's ADV Form using the SEC's Investment Adviser Public Disclosure (IAPD) website.
If you do not find an investment advisory firm in the SEC's IAPD database, contact your state's securities regulator or search the FINRA BrokerCheck database.
Ask questions. You entrust your money to someone else. You have to know where your money is going, who manages it, how it's invested, and how you can get it back. Additionally, you may want to read the FINRA investor warning, which explains some of the risks of investing in hedge fund funds.

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