Hedge Funds

I guess a lot people heard, but not really know who are they – hedge funds? A lot people claimed that they have a good working knowledge about this business, but in reality, not many though. Hedge funds and the managers who run them have been getting a lot of publicity lately, but not of the flattering kind.

We have massive Ponzi schemes, equally massive losses and outsized systemic risks that are enough to frighten away many people, even the hardiest of investors. Nonetheless, they are an integral part of our financial investment landscape and they often outperform the broad stock market by wide margins. And they are now more accessible to investors via a fast-growing new vehicle – funds of hedge funds.

The first hedge funds came out in 1949 – as a strategy to neutralize the effect of overall market movements on a portfolio. Then, the strategy was simply to buy stocks that were expected to rise and selling short stocks expected to fall. The concept was simple – to add balance – to produce returns that were not market-dependent and tended to hedge a portfolio’s market exposure.
Nowadays, that has changed in a very fundamental way – besides protecting a portfolio from downside risk, hedge funds often go for a maximum return by deploying large amounts of leverage and investing in several asset classes among global markets.

Hedge funds are private partnerships that are open to a limited number of investors. To be qualified, usually you need a net-worth greater than $1 million and meet a minimum income requirement.
Institutional investors are also a dominant force behind the rising popularity of hedge funds. Firstly, pension funds – US corporate and government pension funds rarely have enough money in their kitty to cover all their expected future liabilities to their members and this is a major reason why them have reached beyond traditional investment vehicles to seek outsized returns. Secondly, endowments – include colleges and universities as well as charitable institutions. The larger the institution, the higher the percentage of assets invested in hedge funds.

One should not ignore the benefits of investing in hedge funds, including true diversification across multiple asset classes, true global diversification, non-correlation with traditional investments and the concept of absolute returns. Hedge funds exist to make money in any market environment.