Hedge funds – in theory – meet the first two objectives and can produce the results required in point three. They may return better-than-average results, should some of their riskier investments be successful.They can earn positive returns even if the market is down.They lessen the portfolio’s overall exposure to market risk (which securities like equities unavoidably incur).Many investors already have exposure to traditional investments, and therefore look to include alternative investments that are uncorrelated to market performance because: These tactics come with significant risk and are difficult to effectively manage, making them off-limits to highly regulated investment funds (like mutual funds). As a majority shareholder, they can then force fundamental changes within the company to increase its value and equity price. Moreover, they can adopt positions that are highly leveraged, and even use ‘activist’ strategies to become a majority shareholder in a listed company. Several alternative investments face less stringent regulation than traditional funds, which gives them greater latitude in their choice of available instruments and tactics.įor example, a hedge fund manager can borrow shares from an investment bank to short-sell the market and use derivatives like options and futures to hedge positions. Venture capital is a subcategory of private equity, but it specialises in investing in high-potential start-ups.Private equity funds specialise in buying companies with an aim to increase their value by implementing changes to their structure or operations.In addition to hedge funds, unregulated alternative pooled-fund investment vehicles include private equity and venture capital. Highly regulated traditional investment vehicles like mutual funds typically use pooled funds to invest in shares and fixed-income securities like bonds. Three key defining characteristics of hedge funds include: If this happens to a portfolio containing many stocks, the value of the portfolio will likely decrease in step with the market.Īs alternative investment vehicles that can look to opportunities outside of the stock market, and by using derivatives to take short positions in the market, hedge funds stand to earn positive results even when the market is falling. Market risk is the risk that the stock market as a whole will experience a downturn. This relative freedom from regulation allows hedge fund managers to engage in high risk tactics like taking short positions and trading with leveraged derivativesĪ major advantage of hedge funds comes from their ability to mitigate market risk by diversifying an investment portfolio. Unregulated pooled funds, like hedge funds, aren’t constrained to the same degree, and are not available to retail investors.Regulated pooled funds, like mutual funds, are open to retail investors – but, owing to this, they must adhere to the rules and restrictions laid out by the relevant regulatory authority.Investors share the profits, should any be earned. What is sectors trading and how does it work?Ī hedge fund is an unregulated alternative investment vehicle that uses a wide selection of strategies and financial instruments (unavailable to regulated pooled funds) to achieve strong returns independent of market performance.Ī pooled fund collects money from many individual investors with the intention of using the accumulated capital for investment purposes.What are futures and how do you trade them?.
What are options and how do you trade them?.Understand any limitations to time restrictions imposed to redeem shares.Understand how a fund's performance is determined and whether it reflects cash or assets received by the fund as opposed to the manager’s estimate of the change in the value.Understand how a fund’s assets are valued as hedge funds may invest in highly illiquid securities and valuations of fund assets will affect the fees that the manager charges.Evaluate potential conflicts of interest disclosed by hedge fund managers and research the background and reputation of the hedge fund managers.Determine if the fund is using leverage or speculative investment techniques which will typically invest both the investors’ capital and the borrowed money to make investments.Understand the level of risk involved in the fund’s investment strategies and that they equate with personal investing goals, time horizons, and risk tolerance.Read the hedge fund’s documents and agreements which contain information about investing in the fund, the strategies of the fund, the location of the fund, and the risks anticipated by the investment.
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