The Potential of Hedge Fund Returns
Hedge fund investing can be complex. They are created up partnering investors seeking to gain large returns on investments. Hedge fund investors can make risky investments as they seek alternatives to the typical markets. Investing in hedge funds can be lucrative to individuals due to their mystique and the risk involved.
Investors seek out hedge funds due to the excitement they offer. In addition, investors earn a certain level of status due to their willingness to invest in alternative markets – especially if they earn money. If you invest in hedge funds, you should only do it to make profits and not for any ulterior motives.
What are hedge funds?
A hedge fund is a financial partnership used to pool funds. They employ different investing strategies to earn active returns for their investors. Hedge funds could be aggressively managed. They may make use of derivatives while leveraged to generate higher profit returns. A hedge fund strategy may include long-short equity, market neutral, volatility arbitrage, and merger arbitrage. Hedge funds are typically only available to accredited investors.
A.W. Jones & Co, founded by former writer and sociologist Alfred Winslow Jones, launched the very first hedge fund in 1949. Jones wanted to try his luck at managing money while at the same time writing an article about investment trends in 1948. Jones raised $100,000 (including $40,000 of his own money) in capital and attempted to minimize risk by holding long-term stock positions by short selling other stocks.
Jones’ investing innovation is referred to as the long/short equities model. The former writer and sociologist employed leverage to promote returns. In 1952, he changed the blueprint of his investment plan, moving it from a general partnership to a limited partnership. He added a 20% incentive fee to compensate the managing partners.
Jones went down in investment history thanks to being the first person to combine short selling, shared risk through partnership, and a system of compensation based on performance.
Who invests in hedge funds?
Between the 1950s and the 1980s, most outside hedge fund investors were high-net-worth individuals. Since the 1980s, institutional investors have invested in hedge funds to gradually diversify their portfolios.
Nearly 75% of all hedge fund investors are currently located in the United States. There are 5,500 active institutional investors in the hedge fund sector. It should be noted that there is a lack of reporting when it comes to hedge funds. Therefore, different firms offer conflicting figures on statistical data in the industry.
Why invest in hedge funds?
Although hedge fund returns have been up and down over the last few years, they could certainly offer plenty of rewards for those who invest.
Here are some benefits to investing in hedge funds:
- You can make an ‘absolute return’ from your investment. A conservative hedge fund aims to make money from decreasing and increasing markets.
- Hedge funds offer diversification to portfolios often dominated by traditional money investments.
- Past success does not guarantee future success in hedge fund investing. However, the good news is that you are offered superior talent when it comes to managing the funds and investment.
- It is likely that you will receive attractive overall returns from your investment. Some investors consider hedge funds to be the best way to make significant profits in a short span of time. They believe the risk/return is well worth it.
What are the risks for hedge funds?
There are risks involved with hedge funds, which could ultimately turn you off of investing in them. In turn, the risks could make them more attractive for you. There are funds that take large directional bets instead of reducing investment volatility. These moves offer the most risk to investors.
Risks of hedge funds include:
- There is a large barrier to entering the hedge fund arena. To invest in hedge funds, you must have the capital first. Each fund has a minimum investment amount. The average hedge fund requires $1 million minimums to get started. More sizeable funds may start off at around $5 million to $10 million.
- Highly leveraged bets can result in massive losses (or huge gains).
- Hedge funds incur borrowing costs. Prices can also rise without ending.
- Some funds’ initial investment may not be recovered for a certain amount of time. Following this period, an investor’s potential to redeem their capital is typically restricted to a short-term window each quarter or each year. In certain circumstances, an investor’s capital could be frozen for long periods allowing fund managers strategic flexibility.
- Hedge funds are scarily regulated. There is more opportunity for fraud to take place due to the lack regulation. Hedge funds do not have to work within SEC rules.
- Fund managers may invest in almost any asset making hedge funds risky. Popular investments include distressed debt due to the debt being purchased at a lower price and potentially sold with large returns if the struggling company bounces back. There is no guarantee that the struggling company will bounce back and make you a profit.
- Investors may struggle to earn their capital back if the fund collapses.
- Investors in a hedge fund assume all the risk but may not see any of the return.
Should you invest in hedge funds?
Investing in hedge funds depends on the type of individual you are and your net worth. You should consider your portfolio, goals over the short- and long-term, risk profile, liquidity, and other issues. Deciding to invest in hedge funds is not a decision you should take lightly. The risk and barrier to enter the arena are both high. You should consult with an investment advisor before jumping into hedge fund investing.
To invest in a hedge fund, you need to shortlist a group of investment possibilities that use strategies consistent with your own portfolios. You must then due your due diligence and research the hedge fund. Before investing in a hedge fund, consider other hedge funds to diversity the risks. Finally, never invest in a hedge fund for status. Only consider the returns you may make.