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.
If this sounds a lot like an actively managed mutual fund, you’re not wrong. The main difference between a mutual fund and a hedge fund is the amount of risk and diversity of products that a hedge fund can invest in versus a mutual fund.
Usually, a mutual fund is limited to investing in stocks and/or bonds. A hedge fund can invest in many other, often exotic, financial products. These can include real estate, derivatives, commodities, currency, and more.
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. Examples of this strategy would be looking at global trade imbalances, growth of emerging economies, business cycles, and supply and demand.
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 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.