What Is A Hedge Fund? A Jargon-Free Guide

What Is A Hedge Fund? At its most basic, a hedge fund is a partnership between a professional fund manager and investors (often referred to as limited partners). The manager and investors pool money into a fund, using different strategies to grow the fund.

Hedge Fund Strategies While there are hundreds of strategies employed by hedge funds to generate returns for their investors, most can be grouped into four main categories: – Global macro – Directional – Event-driven – Relative value

Global Macro Strategy Hedge funds implementing a global macro strategy look at the big picture economic and political trends worldwide and attempt to capitalize on these large-scale ideas.

Relative Value (Arbitrage) Strategy

A relative value strategy will attempt to take advantage of price discrepancies between securities, otherwise known as arbitrage. Investopedia defines arbitrage as “the simultaneous purchase and sale of the same asset in different markets to profit from tiny differences in the asset’s listed price.

How Can You Invest in Hedge Funds?

Investing in a hedge fund is not as simple as buying a stock. Due to government restrictions and minimum investment thresholds, the average person cannot invest directly in a hedge fund.

How Do Hedge Funds Make Money? Hedge funds make money through their fee structure, as well as their underlying performance.  A typical hedge fund fee structure is “2 and 20”, which means they charge a 2% annual fee on the total assets under management, as well as a performance fee of 20% of the total profit.

Benefits of Hedge Funds

 Flexible Investment Strategies   Unlike mutual funds, hedge funds have more latitude to use strategies such as leverage, short selling, and derivatives to increase returns.

Reduced Losses in Market Downturns  Many hedge fund strategies attempt to be “market neutral” and provide a reasonably consistent return regardless of if the overall market is up or down.

Diversification With the ability to implement many different strategies, allocating some of your portfolio to hedge funds effectively “hedges” your risk of relying on the overall market.

While hedge funds can be a powerful investing tool, they also come with unique risks. For the average person who doesn’t have millions to invest, the high fees and minimums can turn off.

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