Many people have heard the term hedge fund, but the vast majority of people have no idea what they are. Even people who have spent years investing in the stock market and other securities don’t really understand the concept of a hedge fund.
This is a type of limited partnership where the fund manager acts as the general manager and the investors are the partners. The biggest difference between a hedge fund and a regular mutual fund is that hedge funds are not regulated. In order to avoid regulations, the investors in the fund must be what are called “qualified purchasers.” The requirements for this are spelled out in the Investment Company Act. Generally, a hedge fund investor must have a net worth of $1,000,000 or an annual income exceeding $200,000. The government established this requirement to protect small investors from the high risk of hedge fund investing. By establishing those requirements, the possibility of someone losing their entire worth is somewhat minimized.
Like any investment, the goal of this is to realize the maximum return possible on the investment. This often do this by investing in some of the riskiest propositions such as distressed assets, derivatives and junk bonds. If the strategy is successful, huge returns can often be accomplished. But a wrong decision can wipe out an entire portfolio. Two popular hedge fund strategies are short selling and high leverage. Short selling is basically betting that the market will move in one direction or another. Leverage simply means throwing a lot of assets towards an investment in an attempt to affect it in a certain way.
Because these strategies are so risky, investors should understand fully how their particular fund manger plans to invest the capital. Unlike other investments that allow you to be hands off and leave the decisions to the manager, hedge fund investors are expected to be very proactive and involved in the process. If things go really wrong, the managers want to be sure that you knew exactly what was going on every step of the way. If a manger seems to secretive or controlling, perhaps you should look for another fund. For example, if you work in the health care industry and see a future where costs are going to continue to rise while profits shrink, would you want your fund manager to bet all your money on huge health industry profits? This is part of being an informed investor.
One of the biggest advantages of this investing is the lack of regulation. Fund managers can invest in virtually anything they choose without regard to limits or safety. They are famous for buying up distressed properties and turning them into profitable real estate investments. This is also take over distressed businesses and help to restructure them into profitable companies. Investments like these can lead to dramatic returns on investment capital that is simply not possible with other safer forms of investment. Buying assets that are mired in debt allows a hedge fund to purchase those assets for pennies on the dollar.
Hedge funds are one of the most lucrative opportunities in a depressed market. Opportunities to purchase failing companies and other assets abound and with some sound research the assets can be turned around and revived.
With the chance to make a lot of money comes the chance to lose a lot also. Hedge fund is not for everyone, but if you can stomach some risk the rewards can be plentiful.
