Traditional investments (in stocks, bonds and cash) have seen their share of highs and lows, and today their charm seems to have petered out with the introduction of alternative investment vehicles for the increasing pool of high-end, risk takers who are willing to go beyond the fixed income and equity market. Investors looking for higher returns and greater investment flexibility have opted for the complex yet rewarding design of alternative investment.
Large capital pools, a generous mix of investment strategies and risk management features offered by hedge funds increase the odds of investment in this particularly robust style of investment. Capital markets have strengthened following essential price discoveries made by hedge fund practices such as short selling. Private companies invest large amounts of money and thus provide more liquidity to the market, absorbing risks while pursuing different strategies and removing irrationalities from the market.
Hedge funds contribute to greater efficiency of financial markets by targeting inefficiencies and minimizing market distortions. As a result of extensive research that goes into analyzing securities, greater pricing information results in greater pricing efficiency. Hedge funds also give a competitive edge to markets, especially in the U.S. which is home to over 50% of hedge funds managed globally.
While sizeable and complex combinations of funds seem possible only for a smattering of investors out of the diverse pool of investment structures, hedge funds have seen a frenetic pace of growth, to the effect that they are now accessible to the average investor seeking high returns in a volatile equity market. Hedge funds have the ability to increase shareholder value by working towards better management, reduced operating expenses and elevated performance indicators that sustain market returns.
Increased flexibility brings about innovation in financial markets, whereby hedge funds trade different securities in several different markets to maximize returns. They are designed to take on global markets, investing in both long and short positions, and trade derivatives to earn high returns.
The New Hedge Fund Manager
As a new hedge fund manager, you are an entrepreneur setting up an independent venture for himself, distinct from stockbrokers and traditional investment bankers. Therefore, it requires the same assertion and long-term perspective required for setting up a business. This section will guide you through issues concerning the structure and operation of your firm.
Hedge fund managers measure risk in terms of capital loss instead of deviation from a benchmark asset, as in the case of a traditional fund. The exclusive nature of these investment funds renders is a desirability that is hardly missed by the adventurous investor. Embellished with the low-risk and high-diversification tag, the hedge fund is a popular investment option, making its mark in mainstream media and newspapers’ financial reviews.
Hedge Fund Basics
The hedge-fund industry is witnessing an evolution: moving from mass clients to a more institutional clientele, employing dynamic allocation models for broad-based management. Asset growth of hedge fund managers has been doing well since last year, based on its gleaming performance and broad-based inflows. Pension’s and Investments’ annual survey depicted a growth of 15.4% growth in assets of hedge fund managers in the year 2013. Assets of the 25 largest such managers totalled a staggering $715 billion (an increase of 8.4% from last year).
The course that successful hedge fund managers have set has attracted investors looking for high quality fixed-income hedge funds that provide downside protection. Hedge funds require investors to be accredited, implying that they have a certain net worth (usually more than $1million in the US), earn a minimum amount of money annually and demonstrate coherent investor skills in order to administer their authority as professional money managers.
Typically, investors will analyze your track record (preferably three years long) to place their trust in you. This entails being able to display how time tested investment decisions have worked in the past and how repeating these strategies will make for an investment that churn outs the right payoffs for high-net worth individuals.
Investors looking for long-term money relationships are often the ones daring to leapfrog to higher profits annually by investing large monies. Therefore, once you have a strong foothold in hedge fund management, you are likely to see permanent streams of money veer in your direction. This will also save you the trouble of calculating your entry and exit into markets at different points in time, carefully re-articulating your investment strategies to meet investment goals.
Whether your goal is to maximize returns or minimize risks, a fascinating mix of strategies can be put to use in a hedge fund. Over the last six years, the most popular strategy has been the long/short equity strategy, to minimize market exposure and gain from stock gains in the long positions or price falls in short positions.
In cases of extreme market volatility and bearish market trends, some hedge funds offer absolute return regimens where returns are seen to be less correlated with the equity markets than in the traditional investment fund.
A low volatility hedge fund is seen as a workable addition to a low-risk portfolio that seeks to inflate earnings at a pace higher than that offered by fixed-income securities in times of low interest rates. The upside of a hedge fun, then, is that it focuses on specific risks and makes way for a stable income stream that accounts for inflation, something T-bonds are unable to suffice.
Hedge funds can be tailored to incorporate a high-return strategy for the high-end investor. The Global Macro Strategy is a wholesome approach to managing long and short positions based on macroeconomic views of countries. In countries where the onset of a recession is imminent, the fund will need to short sell its securities, while long positions in various equity and futures markets may well increase the probability of racking up greater returns. The global macro also opens up a window into a plethora of derivative securities that you can choose from, to create your high risk/high return profile.
Hiring Commodity Trading Advisors can also help you in forecasting future stock, bonds and currency trends. Another way that you can benefit from creating a hedge fund is by focusing on customizing investment portfolios to meet investor needs. Surveys have shown that more than 60% of investors prefer customized solutions.
Difference between Hedge Funds and Mutual Funds
Most starters will find that hedge funds are considered an alternative to mutual funds due to several underlying factors that distinguish the two types of investment fund structures. The major difference is in the regulation of both funds. While mutual funds are highly regulated (by the SEC in the US), hedge funds structure themselves in a way that exempts them from stringent regulatory standards.
They have far greater flexibility than the average mutual fund in that they can pick and choose to work with several different investment strategies aimed at a certain goal. The ultimate goal of the hedge fund is to maximize returns on the investment, the reason why it is more popular with large investors.