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What is a Hedge Fund?
There is no definition that is
correct.
And, this is not
too bad. When you can not define something, you can not regulate
it:)
So, what is a hedge fund?
A hedge fund is a
collective investment undertaking. This
means next to nothing. Could be anything.
Welcome to the hedge funds world.
“Hedge
funds” are not homogeneous
financial products. In some legal
systems, they are flexible investment vehicles, where managers
operate without limits.
Hedge funds
allow the use of sophisticated management
techniques such as short selling,
leverage, derivatives contracts (swaps, forwards, options, futures
etc.). This can be very profitable. This can be very dangerous too.
How Risky Is a Hedge Fund?
It depends on the fund. Don't
believe that all hedge funds are extremely risky. A high risk
strategy is not suitable for everybody. It can be good for the rich.
Many
countries have laws and regulations in place to protect the poor.
This is the reason we often read
that hedge funds are the investment vehicles suitable for the rich.
The poor
don't usually understand that the laws protect them, but
they believe that they are excluded from
the great opportunities only the rich have.
Many hedge fund managers
also don't find so many rich
people willing to invest. They always have the temptation to market
and sell to ordinary people.
There is a cost for that -
they become regulated hedge funds,
and there is a drastic reduction in the manager’s freedom to
determine the content of the investment.
A number of funds now
permitted under UCITS III could be
characterized as hedge funds. We still call these investment pools
"hedge funds", but there are very different.
Hedge funds are not unregulated, they are simply more loosely
regulated than mutual funds and common trusts run by bank trust
departments.
Private equity partnerships, venture capital
funds, and some real estate partnerships are also loosely regulated,
but they are not hedge funds.
Mutual fund investors may redeem shares
at any time, so mutual fund managers spend a lot of time to deal
with investors, daily valuation etc.
In contrast, hedge
funds allow entry or exit only at certain times of the year,
monthly, quarterly, or annually, and may restrict redemptions for
one or more years.
Hedge
fund managers can spend their time
to make money.
Many hedge
funds can keep their actions relatively secret, handled by offshore
companies in places like the Cayman Islands, where regulation looks
perfect for these vehicles.
There is increasing pressure
from the regulators around the world to disclose more information.
The SEC has proposed to require all hedge fund management companies
to register as investment advisers.
Absolute return strategies
In traditional money management, returns are compared to a
benchmark like the S&P 500. If the S&P 500 is down 10% and our fund
is down only 8%, our losing money investment is great.
Absolute return
strategies lead to profits regardless of what happens to any index.
The hedge fund manager is judged only on the size and consistency of
returns.
Investors refuse to invest in
hedge funds that have less than two years of good performance...
they refuse to invest also in hedge funds that are more than 8 years
old... as they believe that hedge funds don't survive longer than
about eight years.
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