What is a hedge fund?

A hedge fund is an investment company. The functioning of a hedge fund is similar to that of mutual funds in which a fund manager invests large amounts of money belonging to investors

Unlike mutual funds, hedge funds are much less regulated in terms of restrictions. Indeed, they are free to use any investment style they wish and can take positions when the stock price is down using short-selling.

Hedge funds, compared to mutual funds, can also use significant leverage to optimise their returns on investments. The risks to which they are exposed are therefore greater.

Hedge Funds: Truly private funds

Generally speaking, investing in a hedge fund is not open to all types of investors. In order to sort and set aside “incompetent” or insufficiently large investors, many hedge funds only accept “qualified” investors. In order to be considered a “qualified” investor, you must be an institution or individual investor with a net worth of at least $1 million or an annual salary of at least $200,000. In other words, you must be “rich” to invest in a hedge fund.

hedge fund 850x504Accepting only “qualified” investors is one of the factors that allows hedge funds to avoid being so regulated. Other factors also contribute to this, such as the fact that hedge funds do not offer their securities for sale to the public or that hedge funds generally limit their number of investors to 50-100 institutions/individuals.

Another private matter is that hedge funds with funds totalling less than $30 million do not need to be registered with CySEC. In addition, hedge funds that lock investors’ money in their funds for a minimum period of 2 years do not need to be registered with CySEC as well.

Their investors therefore undertake not to be able to withdraw the money they have invested in these hedge funds for two years.

Hedge fund fees

Hedge funds have a management fee structure that is quite specific to them. A hedge fund generally charges an investor 1% to 2% of the total amount of its investment (also called a “general management fee”) as well as 20% to 40% of the capital gains generated by the strategies of the investment fund (called a “performance fee”). A “modest” fee represents a management fee of 1% of the funds invested in the Hedge Fund plus 20% of the performance fee.

hedge fund noteIt is in the interest of a hedge fund manager to generate as much profit as possible in order to earn a higher commission.

In order to protect the investment fund from manager manipulation, some hedge funds have set up a structure to manage commissions based on long-term performance.

This structure called “high-water mark” consists in granting a bonus to managers only if the performance of the investment fund is higher than the previous one.

The different styles of hedge funds

There are thousands of hedge funds around the world and their number is growing rapidly. The largest hedge funds require a minimum investment of nearly $1 million or more, while smaller structures accept a minimum investment of just under $50,000. Although some hedge funds specialise in a particular sector such as technology or commodities, they may just as easily specialise in a single region, country or continent such as Asia or Eastern Europe etc…

On the other hand, a hedge fund may also have different investment styles:

Market neutral: The objective of this strategy is to limit risk by investing in a pair of financial instruments. These hedge funds are also called “Long-Short Funds”. The manager “Buys” an action he thinks is undervalued and “Sell” at the same time another action he thinks is overvalued. As a result, some market risks are hedged.

Arbitration: The job of the managers of these funds is to identify the prices of financial instruments that are not correctly established by the market in order to benefit from them. A hedge fund manager can just as easily buy a company’s convertible bonds and at the same time sell the shares of the same company if he considers their price too high compared to what they should be.

Distressed Securities : The managers of these funds concentrate their investments in financial instruments that are offered at discount prices due to problems at the level of the companies or the sector in which they are located. For example, a manager may buy shares in a company that is on the verge of bankruptcy if he thinks it will increase in the near future.

Macro: Hedge funds that use this investment style try to take advantage of changes in the global economy such as changes in political laws that affect interest rates, currencies, or commodity prices.

Short-Selling: Unlike “Long-Short” funds, the manager of a Hedge Fund short selling only takes positions on the markets by selling short. That is, to make a profit on falling prices.

Market timing: These hedge funds attempt to identify trends in a particular sector or in international markets in general.