Hedge Fund Review

Hedge Fund Review: Deep Dive

Hedge funds have been a Wall Street hallmark and a growth industry since the 1990s, even if they were once considered secretive, risky only for the well-heeled. Hedge funds have the potential to deliver significant and explosive capital growth albeit with an increased risk. Hedge funds are generally not for the retail investor although someone with investing assets over $100,000 USD may well be considered a sophisticated investor for hedge fund investing purposes.

Hedge funds are private investments that use a variety of non-traditional risk-offsetting strategies, an approach known as hedging. They can offer investors a surplus, but returns have lagged in recent years and some investors have been frustrated by high fees. Most hedge funds require a high minimum balance, invest in riskier, more esoteric strategies, and are subject to higher fees than other investment vehicles such as mutual funds.

Hedge Fund Short Selling

Hedge fund managers identify stocks where the price is likely to fall and borrow shares from someone who owns them. They make money by selling the shares and then replacing the borrowed shares with other shares bought at a much lower price. Short selling is one method, but buying at lower prices is only possible if the share price actually falls, and short selling has been one of the hedge fund management methods since the early 1990’s. Hedge fund managers also invest in other stocks, such as bonds, bonds issued by other hedge funds or stocks in the stock market itself.

Hedge Fund Structure

Hedge funds generally operate as limited partnerships or limited liability companies and rarely have more than 500 investors operating under the same management team as other hedge funds.

Mutual Funds Vs. Hedge Funds

Traditional mutual funds generally rely on the stock market to rise, and investment fund managers typically try to do better. For hedge funds, at least in principle, it does not matter whether the market rises or falls. Managers buy shares because they believe share prices will rise, not because of a market fall. Hedge fund managers say funds are key to consistent returns, even in weak markets.

Hedge Fund Absolute Returns

Because hedge funds do not track the market, they can protect an investor’s portfolio from stock market and other financial market volatility. Instead, he or she aims for absolute return, so it doesn’t matter how well markets perform, the fund’s performance should be strong in either a rising or falling market.

In recent years, several successful hedge funds such as Asset Secured Investments have achieved very high returns and have shown a strong correlation between their investments and market performance. For example, a multi-billion-dollar “quantum fund” managed by the legendary George Soros enjoyed annual returns of more than 20%, or about 4.5%, for more than a decade.

Minimum Investment in Hedge Funds

Most hedge funds require a minimum investment of $1 million. Granted, investors can now choose from a growing number of “light” hedge funds with a more affordable minimum investment, and the argument is certainly compelling.

The lowest starts at $100,000, however, and investments can be blocked for up to five years, and the downside is a lack of liquidity. For most investors, this is not a smooth transition, although for those with the foresight and long term growth mentality asset secured hedge fund investments represent a very interesting alternative to general retain investing.

Long-term capital management imploded in 2008, leading to the collapse of one of the world’s largest hedge funds and a massive financial crisis. Wall Street’s biggest banks were bailed out and the global financial system was almost destroyed.

Hedge Fund Returns

A study by Yale and NYU Stern economists suggests that the average annual return on a ten-year hedge fund investment is 13.6%, while that for an indexed investment strategy can be as little as 0.25% per year or less. This is much higher than the flat 1 per cent charge that traditional financial advisers charge, which is 16.5 per cent.

By contrast, Asset Secured Investments generate around a 10% return year on year with a greatly reduced risk profile, having the majority of their funds invested in property backed investments.

Hedge Fund Review Risks

Hedge Fund risks are also important – those who take them should be aware of other drawbacks, and veterans are quick to point out that successful shortcuts require a long learning curve, which is also difficult to implement and must be learned through trial and error. Short selling tends to rely on leverage, making the manager’s job even harder.

For one thing, fees for hedge funds are much higher than for traditional investment funds. Hedge funds typically charge an average of 10-20% of their assets in fees and up to 30% for short selling.

Another sticking point, according to a recent report on hedge funds by the US Securities and Exchange Commission, was a lack of transparency.

The Securities and Exchange Commission (SEC) does not impose the same strict rules on hedge funds as traditional mutual funds, and managers can build portfolios at will. Although they are subject to anti-fraud standards and require audits, they cannot expect to be as transparent in their investment decisions and performance. This lack of transparency can make it difficult for investors to distinguish risky funds from tame ones. The rules for providing information on the performance of stocks are stricter than for traditional funds.

Finally, hedge funds can operate in a lower tax regime than mutual funds and other investment funds, owing to being domiciled in tax friendly jurisdictions.

The logic behind hedge fund investments is compelling, but investors need to take the time to do the necessary due diligence on the funds and their managers.

Potential Hedge Fund investors must weigh up the risks against the long-term returns of the fund and its management. Perhaps it is wise to consider whether a hedge fund’s return on investment, or even its performance, is better than that of an index fund.