Thinking of Hedging Funds? A hedge fund is primarily an investment store contributed by a limited number of partners or investors and it is usually operated by a professional manager with specific goals in mind.
These goals in Hedging funds are basically to maximize returns and minimize risk. Due to their nature, hedge funds are typically only open to qualified partners although not exclusively. Hedge funds do need high minimum investment or net worth, constituting of wealthy clients.
Most times, Hedge funds include buying with borrowed money and trading esoteric assets, in an effort to beat average investment returns for their clients. They are considered risky alternative investment choices.
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What is Hedging funds?
Hedge funds is an investment channel that constitutes high-net-worth individuals, institutional investors, and other accredited investors. These hedging funds are historically focused on hedging risk by simultaneously buying and shorting assets in a long-short equity strategy.
Key Characteristics of Hedge Funds
There is a huge difference between a hedge fund and a mutual fund. These are the key characteristics of hedging funds:
- Hedge Funds Exclude Small Investors
Hedge funds can only accept money from investors who are qualified. These qualified partners are individuals with an annual income that exceeds $200,000 for the past two years or a net worth exceeding $1 million, excluding their primary residence.
- Hedge Fund Managers Have a Wide Latitude
Hedge fund’s investment is only limited by its mandate. A hedge fund can basically invest in anything ranging Land, real estate, stocks, derivatives, and currencies.
- Hedge Funds Often Use Leverage
Hedge funds often make use of borrowed money to amplify their returns and allow them to take aggressive short positions. Leverage can wipe out hedge funds, along with other big chunks of the economy.
- Hedge Funds Have a “2 and 20” Fee Structure
In the last few years, mutual funds fees have fallen substantially, hitting an average of 0.50% in 2020. By contract, Hedge funds, make use of a fee structure that is called, in shorthand, “2-and 20.” That’s 2% of the assets under management plus a 20% cut of any profits generated.
Risk involved in Hedging funds
The following are some of the risk associated with hedge funds:
- With hedge funds, the concentrated investment strategy exposes funds to potentially huge losses.
- Hedge funds usually require investors to lock up money for a period of years.
- The use of leverage, or borrowed money, may turn a minor loss into a disastrous one.
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Guidelines when choosing a hedge fund
Because of the risk involved in Hedging funds, there are some precautions to watch out for when choosing a particular hedge fund:
- The first step is to identify the metrics that are important to each hedge funds and the results required for each
- Analyze the annualized rate of return, this will help reveal funds with much higher expected returns, such as global macro funds, long-biased long/short funds, and others.
- Examine the standard deviation of the index over the previous five years
- Set a Relative performance metrics
Some other factors to consider in Hedging funds includes:
- Five-year annualized returns
- Standard deviation
- Rolling standard deviation
- Months to recovery/maximum drawdown
- Downside deviation
To be a Hedge fund investor, you must be willing to take risk because it comes with certain unavoidable risks