Hedge Fund Definition
Hedge funds are limited partnerships made up of individual investors whose money is overseen by qualified fund managers. Hedge funds pool investor funds and make investments in an effort to generate a profit.
A hedge fund are a portfolio of various investments managed aggressively, generally due to the strategies used. The main goal of such investments is to get higher returns compared to other investments. So basically, they are privately owned companies that pool money from investors to reinvest them in a group of financial instruments to achieve higher returns.
They are absolute return funds that invest in stocks, bonds, commodities, currencies, and derivatives within the financial markets. Alternatively, they may apply non-traditional portfolio management techniques like short selling, leveraging, arbitrage, swaps, etc.
Initially conceived in the US (1949), hedge funds flourished in the late eighties and now form an integral part of institutional and private client portfolios.
Who can invest?
Generally, they are often set up as private investment partnerships open to a limited number of investors requiring a large amount of minimum investment. So, investments in Hedge funds are available only to sophisticated investors, such as institutions and individuals with substantial assets.
Generally, Accredited Investors, corporate treasuries, institute institutions of funds, private banks, endowments, and pensions invest in funds.
An accredited investor can invest in the Hedge Fund. He must meet the following criteria for investing in a fund-
- Has a net worth of more than $1 million, owned alone or jointly with a spouse
- Has earned $200,000 in each of the past two years
- Has earned $300,000 in each of the past two years when combined with a spouse
- Has some rational expectation of making the same amount in the future
The primary qualification for investment institutions, such as pensions, endowments, and trusts, is having $5 million in assets.
The minimum investment required
The minimum investment required for investing varies from fund to fund. However, some funds charge as low as US$10,000. Such a fund is an exception. The expected starting range would be between US$250,000-$500,000. Established funds may have much higher minimums requirements, up to $10,000,000 or more, which can depend on the fund and manager.
Critical features
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Absolute returns
Hedge fund managers chase absolute returns rather than returns comparatively to an index or benchmark. This allows them to generate gains even when the traditional market conditions are range bound or underperforming.
- Applications of Skill-based strategies
Skills of a Hedge fund manager play a key role in generating returns by executing a specifically chosen strategy rather than relying on asset appreciation in rising markets.
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Flexibility
It can be traded on various financial instruments’ long and short sides.
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Diversity
Hedge funds can be traded across a range of markets and exchanges. Also, the investments can be in diverse financial instruments, including equities, bonds, currencies, and derivatives.
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Alignment of interest
Hedge fund managers frequently invest their own money, aligning their interests with their investors.
History of Hedge Funds
Began in 1949 when Alfred Winslow Jones started an investment partnership. This partnership is regarded as the first hedge fund. But, remarkably, many of the ideas and strategies he introduced over fifty years ago remain vital to the industry.
In the Hedge fund, Jones committed his own money to the partnership and based his compensation on a performance incentive fee of 20% of profits.
The industry was born in 1966; an article in Fortune magazine emphasized an investment that outperformed every mutual fund on the market.
Then the industry was relatively quiet for two decades due to losses. But in 1986, yet another article in ‘Institutional investor’ caught the attention of the investors due to the double-digit returns that the fund made.
But ‘Today,’ the industry thrives despite the troubles. Modern funds have seen various returns, investment requirement changes, strategies, etc.
Fee Structure
Generally, compensation for a Hedge Fund Manager is of two types-
- Management fee
- Incentive Fee
A Management fee is usually a percentage of the size of the fund, and an incentive fee is performance-based. Typically charge a management fee of 2% of assets managed, but in some cases, it can be even higher if the manager is in high demand. Most charge an incentive fee between 10-20% of profits.
Investment Strategies
1. Long Only
It is a strategy where a owns long positions in stocks or other assets. This strategy looks for alpha to the upside to outperform their benchmarks. If the S&P 500 is the fund’s benchmark, up 10%, and the hedge fund is up 15%, the extra 5% between the two is the alpha generated by the portfolio manager.
2. Short Only
It is a complicated strategy. In this strategy, the only sells stock short.
3. Long/Short
It is a strategy where the hedge fund is long or owns and sells stock short.
For example, if there are ABC Corp (Long) and XYZ Corp ( Short) stocks. Such a strategy gives exposure to both sides of the trade. The exposure is maybe 70% long and 30% short for a net equity exposure of 40% (70% – 30%).
4. Market Neutral
Market neutrality is a strategy accomplished in two ways. When there are equal amounts of investment in both long and short positions, the net exposure of the fund would be zero.
For example, if 50-50 percent of the funds are invested in long and short positions, the net exposure would be 0%, making the gross exposure 100%.
5. Equity Arbitrage
These funds are typically for takeovers, especially when they are done with stock or stock plus cash.
6. Event-Driven
These funds look for any item or news that can move the market. Such managers have computer programs that constantly scan for headlines around the world. Even five seconds of lead time is essential here. The moment when the fund has the data, it can short the S&P 500 seconds in front of the news, and it can make handsome money.
7. Fixed-Income Arbitrage
Fixed-income arbitrage funds make returns from risk-free government bonds, eliminating credit risk.
8. Global Macro
Using this strategy, analyze how the macroeconomic trends may affect various factors like interest rates, currencies, commodities, or equities and take long or short positions in most sensitive assets.
Major Companies in the world
- Bridgewater Associates
- Man Group
- JPMorgan Asset Management
- Brevan Howard Asset Management
- Paulson & Co.
- BlackRock Advisors
- Winton Capital Management
- Highbridge Capital Management
- BlueCrest Capital Management
Companies in India
- HFG India Continuum Fund
- India Deep Value Fund
- Fair value
- Atyant Capital
- India Capital Fund
Career
The career track of an Analyst includes the following-
1. Analyst the following- 2-3 years
2. Senior analyst- 1-3 years
3. Portfolio manager
The career track of a trader includes the following-
1. Execution trader the following- 1-3 years
2. Senior trader
Salary
Compensation for an Analyst varies based on the fund and its performance.
Generally, investment bankers or MBA students with little or no prior experience are expected to earn up to $90,000-$120,000 (Subject to change).
Traders with little or no experience can expect a base of $50,000-$80,000 (Subject to change).
Essential steps to become a Manager
1. Be sure that working for a Hedge Fund is genuinely your passion
Learn about hedge funds as much as you can. If you want to work for a hedge fund, it will be portrayed in your discipline, interaction, industry knowledge, passion, and actions.
2. Become a Student of the Hedge Fund Industry
You may subscribe to hedge fund newsletters and read books on hedge funds. Grab as much information about the significant players, essential definitions, strategies, etc.
3. Recognize your Career Mentors
You must try to identify potential mentors who may help you and build relationships with them.
4. Take Hedge Fund internships
Start looking for internships in Hedge funds
5. Identify your interest
At this stage, you must be able to categorize
What type of job would you like?
- The types of responsibilities you are looking forward to?
6. Find a Job!!!
Find unadvertised job openings by either cold-calling companies or looking for such spaces online.
The best routes for getting that placement are:
- Be in touch with the professionals who graduated from your school
- You can also Join any Group
- Receiving your CFA, CAIA, or CHA title
- Attending various conferences where you can connect with the professionals
Queries
Hedging- Meaning?
Hedging means managing or mitigating the risk. There are many innumerable investment risks like market, Interest rate, Inflation, Regional, Currency, etc. Hedge fund managers apply the complete resource of financial strategies to mitigate the above-given risks.
Can hedge Funds not be hedged?
Yes, but this raises the question of how they can call themselves “hedge” funds. The answer is that some funds may be long-only in stocks and may even use leverage, making them speculative and unhedged.
Is every hedge fund aggressive?
The answer here is no; not all the funds are aggressive. Although some aggressive hedge funds exist, many others clearly and systematically follow the consistency of returns and capital conservation.
What are offshore hedge funds, and who can invest in them?
These hedge funds are registered in offshore jurisdictions. Such funds are designed to allow investment without being exposed to the rebukes of tax law in any given onshore legislation. Any qualified investor with offshore money can invest in such funds.
Are fees to be paid even if the fund loses money?
Yes, the management fees must be paid, but the incentive fees apply only after the positive performance is obtained.
What is the meaning of the Hurdle rate?
A hurdle rate is a minimum return an investment must make before applying incentive fees.
What does a lock-up period in a hedge fund mean?
It is the period to hold the assets within a fund before they are to be removed.
