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Home > Finance > Mutual Funds > Hedge funds - establishing a new frontier
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Hedge funds - establishing a new frontier
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It is difficult to provide a general definition of a hedge fund.
Initially, hedge funds would sell short the stock market, thus
providing a "hedge" against any stock market declines. Today the term
is applied more broadly to any type of private investment partnership.
There are thousands of different hedge funds globally. Their primary
objective is to make lots of money, and to make money by investing in
all sorts of different investments and investments strategies. Most of
these strategies are more aggressive than than the investments made by
mutual funds.
A hedge fund is thus a private investment fund, which invests in a
variety of different investments. The general partner chooses the
different investments and also handles all of the trading activity and
day-to-day operations of the fund. The investor or the limited partners
invest most of the money and participate in the gains of the fund. The
general manager usually charges a small management fee and a large
incentive bonus if they earn a high rate of return.
While this may sound a lot like a mutual fund, there are major differences between mutual fund and hedge fund:
1. Mutual funds are operated by mutual fund or investment companies and
are heavily regulated. Hedge funds, as private funds, have far fewer
restrictions and regulations.
2. Mutual fund companies invest their client's money, while hedge funds
invest their client's money and their own money in the underlying
investments.
3. Hedge funds charge a performance bonus: usually 20 percent of all
the gains above a certain hurdle rate, which is in line with equity
market returns. Some hedge funds have been able to generate annual
rates of return of 50 percent or more, even during difficult market
environments.
4. Mutual funds have disclosure and other requirements that prohibit a
fund from investing in derivative products, using leverage, short
selling, taking too large a position in one investment, or investing in
commodities. Hedge funds are free to invest however they wish.
5. Hedge funds are not permitted to solicit investments, which is
likely why you hear very little about these funds. During the previous
five years some of these funds have doubled, tripled, quadrupled in
value or more. However, hedge funds do incur large risks and just as
many funds have disappeared after losing big.
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