whatis a hedge fund?

Answer 1

A hedge fund is a private investment fund charging a performance fee and typically open to only a limited range of qualified investors. In the United States, hedge funds are open to accredited investors only. Because of this restriction, they are usually exempt from any direct regulation by regulatory bodies. Hedge funds are credited to Alfred Winslow Jones for their invention in 1949.

As a hedge fund's investment activities are limited only by the contracts governing the particular fund, it can make greater use of complex investment strategies such as short selling, entering into futures, swaps and other derivative contracts and leverage.

As their name implies, hedge funds often seek to offset potential losses in the principal markets they invest in by hedging via any number of methods. However, the term "hedge fund" has come in modern parlance to be overused and inappropriately applied to any absolute-return fund – many of these so-called "hedge funds" do not actually hedge their investments.

Hedge funds have acquired a reputation for secrecy. Unlike open-to-the-public "retail" funds (e.g., U.S. mutual funds) which market freely to the public, in most countries, hedge funds are specifically prohibited from marketing to investors who are not professional investors or individuals with sufficient private wealth. This limits the information a hedge fund can legally release. Additionally, divulging a hedge fund's methods could unreasonably compromise their business interests; this limits the information a hedge fund would want to release.

Since hedge fund assets can run into many billions of dollars and will usually be multiplied by leverage, their sway over markets, whether they succeed or fail, is potentially substantial and there is a continuing debate over whether they should be more thoroughly regulated.
Industry

In 2005, Absolute Return magazine found there were 196 hedge funds with $1 billion or more in assets, with a combined $743 billion under management - the vast majority of the industry's estimated $1 trillion in assets. However, according to hedge fund advisory group Hennessee, total hedge fund industry assets increased by $215 billion in 2006 to $1.442 trillion, up 17.5% on a year earlier, an estimate for 2005 seemingly at odds with Absolute Return.

As large institutional investors have entered the hedge fund industry the total asset levels continue to rise. The 2008 Hedge Fund Asset Flows & Trends Report [4] published by HedgeFund.net and Institutional Investor News estimates total industry assets reached $2.68 trillion in Q3 2007.

Fees

Usually the hedge fund manager will receive both a management fee and a performance fee (also known as an incentive fee). Performance fees are closely associated with hedge funds, and are intended to incentivize the investment manager to produce the largest returns possible.

Management fees

As with other investment funds, the management fee is calculated as a percentage of the net asset value of the fund at the time when the fee becomes payable. Management fees typically range from 1% to 4% per annum, with 2% being the standard figure. Therefore, if a fund has $1 billion of assets at the year end and charges a 2% management fee, the management fee will be $20 million in total. Management fees are usually calculated annually and paid monthly.

Performance fees

Performance fees, which give a share of positive returns to the manager, are one of the defining characteristics of hedge funds. In contrast to retail investment firms, performance fees are prohibited in the U.S. for stock brokers.[citation needed] A hedge fund's performance fee is calculated as a percentage of the fund's profits, counting both unrealized profits and actual realized trading profits. Performance fees exist because investors are usually willing to pay managers more generously when the investors have themselves made money. For managers who perform well the performance fee is extremely lucrative.

Typically, hedge funds charge 20% of gross returns as a performance fee, but again the range is wide, with highly regarded managers demanding higher fees. In particular, Steven Cohen's SAC Capital Partners charges a 50% incentive fee (but no management fee) and Jim Simons' Renaissance Technologies Corp. charged a 5% management fee and a 44% incentive fee in its flagship Medallion Fund before returning all investors' capital and running solely on its employees' money.[citations needed]

Managers argue that performance fees help to align the interests of manager and investor better than flat fees that are payable even when performance is poor. However, performance fees have been criticized by many people, including notable investor Warren Buffett, for giving managers an incentive to take excessive risk rather than targeting high long-term returns. In an attempt to control this problem, fees are usually limited by a high water mark and sometimes by a hurdle rate. Alternatively, the investment manager might be required to return performance fees when the value of the fund drops. This provision is sometimes called a ‘claw-back.’


High water marks

A "High water mark" is often applied to a performance fee calculation. This means that the manager does not receive performance fees unless the value of the fund exceeds the highest net asset value it has previously achieved. For example, if a fund was launched at a net asset value (NAV) per share of $100, which then rose to $130 in its first year, a performance fee would be payable on the $30 return for each share. If the next year it dropped to $120, no fee is payable. If in the third year the NAV per share rises to $143, a performance fee will be payable only on the extra $13 return from $130 to $143 rather than on the full return from $120 to $143.

This measure is intended to link the manager's interests more closely to those of investors and to reduce the incentive for managers to seek volatile trades. If a high water mark is not used, a fund that ends alternate years at $100 and $110 would generate performance fee every other year, enriching the manager but not the investors. However, this mechanism does not provide complete protection to investors: a manager who has lost money may simply decide to close the fund and start again with a clean slate -- provided that he can persuade investors to trust him with their money. A high water mark is sometimes referred to as a "Loss Carryforward Provision."

Poorly performing funds frequently close down rather than work without fees, as would be required by their high water mark policies.

Hurdle rates

Some funds also specify a hurdle rate, which signifies that the fund will not charge a performance fee until its annualized performance exceeds a benchmark rate, such as T-bills or a fixed percentage, over some period. This links performance fees to the ability of the manager to do better than the investor would have done if he had put the money elsewhere.

Though logically appealing, this practice has diminished as demand for hedge funds has outstripped supply and hurdles are now rare.

Strategies

Hedge funds are no longer a homogeneous class. Under certain circumstances, an investor or hedge fund can completely hedge the risks of an investment, leaving pure profit.[citation needed] For example, at one time it was possible for exchange traders to buy shares of, say, IBM on one exchange and simultaneously sell them on another exchange, leaving pure profit.[citation needed] Competition among investors has leached away such profits, leaving hedge fund managers with trades that are partially hedged, at best. These trades still contain residual risks which can be considerable. Some styles of hedge fund investing, such as global macro investing, may involve no hedging at all. Strictly speaking, it is not accurate to call such funds hedge funds, but that is current usage.

The bulk of hedge funds describe themselves as long / short equity, but many different approaches are used taking different exposures, exploiting different market opportunities, using different techniques and different instruments:

* Global macro – seeking related assets that have deviated from some anticipated relationship.
* Arbitrage – seeking assets that are mispriced relative to related assets.
o Convertible arbitrage – between a convertible bond and the same company's equity.
o Fixed income arbitrage – between related bonds.
o Risk arbitrage – between securities whose prices appear to imply different probabilities for one event.
o Statistical arbitrage (or StatArb) – between securities that have deviated from some statistically estimated relationship.
o Derivative arbitrage – between a derivative and its security.
* Long / short equity – generic term covering all hedged investment in equities.
o Short bias – emphasizing or solely using short positions.
o Equity market neutral – maintaining a close balance between long and short positions.
* Event driven – specialized in the analysis of a particular kind of event.
o Distressed securities – companies that are or may become bankrupt.
o Regulation D – distressed companies issuing securities.
o Merger arbitrage - arbitrage between an acquiring public company and a target public company.
* Other – the strategies below are sometimes considered hedge strategies, although in several cases usage of the term is debatable.
o Emerging markets- this usually means unhedged, long positions in small overseas markets.
o Fund of hedge funds - unhedged, long only positions in hedge funds (though the underlying funds, of course, may be hedged). Additional leverage is sometimes used.
o Quantitative
o 130-30 funds - Through leveraging, 130% of the money invested in the fund is used to buy stocks. 30% of the money invested in the fund is used to short stock.

Hedge fund risk

Investing in a hedge fund is considered to be a riskier proposition than investing in a regulated fund, despite the traditional notion of a "hedge" being a means of reducing the risk of a bet or investment. The following are some of the primary reasons for the increased risk:

Leverage - in addition to putting money into the fund by investors, a hedge fund will typically borrow money, with certain funds borrowing sums many times greater than the initial investment. Where a hedge fund has borrowed $9 for every $1 invested, a loss of only 10% of the value of the investments of the hedge fund will wipe out 100% of the value of the investor's stake in the fund, once the creditors have called in their loans. At the beginning of 1998, shortly before its collapse, Long Term Capital Management had borrowed over $26 for each $1 invested.

Short selling - due to the nature of short selling, the losses that can be incurred on a losing bet are theoretically limitless, unless the short position directly hedges a corresponding long position. Therefore, where a hedge fund uses short selling as an investment strategy rather than as a hedging strategy it can suffer very high losses if the market turns against it.

Appetite for risk - hedge funds are culturally more likely than other types of funds to take on underlying investments that carry high degrees of risk, such as high yield bonds, distressed securities and collateralised debt obligations based on sub-prime mortgages.

Lack of transparency - hedge funds are secretive entities. It can therefore be difficult for an investor to assess trading strategies, diversification of the portfolio and other factors relevant to an investment decision.

Lack of regulation - hedge funds are not subject to as much oversight from financial regulators, and therefore some may carry undisclosed structural risks.

Investors in hedge funds are willing to take these risks because of the corresponding rewards. Leverage amplifies profits as well as losses; short selling opens up new investment opportunities; riskier investments typically provide higher returns; secrecy helps to prevent imitation by competitors; and being unregulated reduces costs and allows the investment manager more freedom to make decisions on a purely commercial basis.
Legal structure

A hedge fund is a vehicle for holding and investing the funds of its investors. The fund itself is not a genuine business, having no employees and no assets other than its investment portfolio and a small amount of cash, and its investors being its clients. The portfolio is managed by the investment manager, which has employees and property and which is the actual business. An investment manager is commonly termed a “hedge fund” (e.g. a person may be said to “work at a hedge fund”) but this is not technically correct. An investment manager may have a large number of hedge funds under its management.

Domicile

The specific legal structure of a hedge fund – in particular its domicile and the type of entity used – is usually determined by the tax environment of the fund’s expected investors. Regulatory considerations will also play a role. Many hedge funds are established in offshore tax havens so that the fund can avoid paying tax on the increase in the value of its portfolio. An investor will still pay tax on any profit it makes when it realises its investment, and the investment manager, usually based in a major financial centre, will pay tax on the fees that it receives for managing the fund.

At the end of 2004 55% of the world’s hedge funds, accounting for nearly two-thirds of total hedge fund assets, were established offshore. The most popular offshore location was the Cayman Islands, followed by the British Virgin Islands, Bermuda and the Bahamas. The US was the most popular onshore location, accounting for 34% of funds and 24% of assets. EU countries were the next most popular location with 9% of funds and 11% of assets. Asia accounted for the majority of the remaining assets.

The legal entity

Limited partnerships are principally used for hedge funds aimed at US-based investors who pay tax, as the investors will receive relatively favorable tax treatment in the US. The general partner of the limited partnership is typically the investment manager (though is sometimes an offshore corporation) and the investors are the limited partners. Offshore corporate funds are used for non-US investors and US entities that do not pay tax (such as pension funds), as such investors do not receive the same tax benefits from investing in a limited partnership. Unit trusts are typically marketed to Japanese investors. Other than taxation, the type of entity used does not have a significant bearing on the nature of the fund.

Many hedge funds are structured as master/feeder funds. In such a structure the investors will invest into a feeder fund which will in turn invest all of its assets into the master fund. The assets of the master fund will then be managed by the investment manager in the usual way. This allows several feeder funds (e.g. an offshore corporate fund, a US limited partnership and a unit trust) to invest into the same master fund, allowing an investment manager the benefit of managing the assets of a single entity while giving all investors the best possible tax treatment.

The investment manager, which will have organized the establishment of the hedge fund, may retain an interest in the hedge fund, either as the general partner of a limited partnership or as the holder of “founder shares” in a corporate fund. Founder shares typically have no economic rights, and voting rights over only a limited range of issues, such as selection of the investment manager – most of the fund’s decisions are taken by the board of directors of the fund, which is self-appointing and independent but invariably loyal to the investment manager.

Open-ended nature

Hedge funds are typically open-ended, in that the fund will periodically issue additional partnership interests or shares directly to new investors, the price of each being the net asset value (“NAV”) per interest/share. To realise the investment, the investor will redeem the interests or shares at the NAV per interest/share prevailing at that time. Therefore, if the value of the underlying investments has increased (and the NAV per interest/share has therefore also increased) then the investor will receive a larger sum on redemption than it paid on investment. Investors do not typically trade shares between themselves and hedge funds do not typically distribute profits to investors before redemption. This contrasts with a closed-ended fund, which has a limited number of shares which are traded between investors, and which distributes its profits.

Listed funds

Corporate hedge funds often list their shares on smaller stock exchanges, such as the Irish Stock Exchange, in the hope that the low level of quasi-regulatory oversight will give comfort to investors and to attract certain funds, such as some pension funds, that have bars or caps on investing in unlisted shares. Shares in the listed hedge fund are not traded on the exchange, but the fund’s monthly net asset value and certain other events must be publicly announced there.

A fund listing is distinct from the listing or initial public offering (“IPO”) of shares in an investment manager. Although widely reported as a "hedge-fund IPO"[8], the IPO of Fortress Investment Group LLC was for the sale of the investment manager, not of the hedge funds that it managed.[9]

Hedge fund management worldwide

In contrast to the funds themselves, hedge fund managers are primarily located onshore in order to draw on larger pools of financial talent. The US East coast – principally New York City and the Gold Coast area of Connecticut (particularly Stamford and Greenwich) – is the world's leading location for hedge fund managers with approximately double the hedge fund managers of the next largest centre, London. With the bulk of hedge fund investment coming from the US, this distribution is natural.

London is Europe’s leading centre for the management of hedge funds. At the end of 2006, three-quarters of European hedge fund investments, totalling $400bn (£200bn), were managed from London, having grown from $61bn in 2002. Australia was the most important centre for the management of Asia-Pacific hedge funds, with managers located there accounting for approximately a quarter of the $140bn of hedge fund assets managed in the Asia-Pacific region in 2006.

Answer 2

It is a special class of funds for sophisticated investors with at least $5 million in investable funds, or a yearly income of $200k.

These funds are very lightly regulated, so their strategies are riskier, which is why only sophisticated investors are allowed to invest in a hedge fund.

The trademark hedge fund strategy is one which uses both long buys and short sells, to HEDGE their investments, so that the aim is to profit in both bull and bear markets. Profiting in both markets obviously requires elevated risk. They can do that because of how lightly regulated they are, otherwise, if it were a mutual fund, the SEC might shut them down for something the same things hedge funds do.

Also, hedge funds employ arbitrage strategies, value strategies, growth strategies, and special secret strategies such as financial models, and computer algorithms. They have lots of freedom, and they make BUTTLOADS of money doing what they love. I wish to join them one day...

Answer 3

Hedge funds are speculative funds which make large bets on market movements. They utilize borrowed money to substantially leverage their returns (and losses), often at a factor of ten to one, or more. They purchase exotic securities and also take substantial short positions when they think the market or a particular sector of the market will go down. Such funds are extremely risky and are suitable for high-wealth investors only.

Answer 4

Here's the short answer. Hedge funds are glorified scams that are not regulated by any government agency. Some of them do well for their clients, but a vast majority are in the business of simply ripping their clients off.

Answer 5

A hedge fund is a private investment fund charging a performance fee and typically open to only a limited range of qualified investors. In the United States, hedge funds are open to accredited investors only. Because of this restriction, they are usually exempt from any direct regulation by regulatory bodies. Hedge funds are credited to Alfred Winslow Jones for their invention in 1949.

As a hedge fund's investment activities are limited only by the contracts governing the particular fund, it can make greater use of complex investment strategies such as short selling, entering into futures, swaps and other derivative contracts and leverage.

As their name implies, hedge funds often seek to offset potential losses in the principal markets they invest in by hedging via any number of methods. However, the term "hedge fund" has come in modern parlance to be overused and inappropriately applied to any absolute-return fund – many of these so-called "hedge funds" do not actually hedge their investments.

Hedge funds have acquired a reputation for secrecy. Unlike open-to-the-public "retail" funds (e.g., U.S. mutual funds) which market freely to the public, in most countries, hedge funds are specifically prohibited from marketing to investors who are not professional investors or individuals with sufficient private wealth. This limits the information a hedge fund can legally release. Additionally, divulging a hedge fund's methods could unreasonably compromise their business interests; this limits the information a hedge fund would want to release.

Since hedge fund assets can run into many billions of dollars and will usually be multiplied by leverage, their sway over markets, whether they succeed or fail, is potentially substantial and there is a continuing debate over whether they should be more thoroughly regulated.
Industry

In 2005, Absolute Return magazine found there were 196 hedge funds with $1 billion or more in assets, with a combined $743 billion under management - the vast majority of the industry's estimated $1 trillion in assets. However, according to hedge fund advisory group Hennessee, total hedge fund industry assets increased by $215 billion in 2006 to $1.442 trillion, up 17.5% on a year earlier, an estimate for 2005 seemingly at odds with Absolute Return.

As large institutional investors have entered the hedge fund industry the total asset levels continue to rise. The 2008 Hedge Fund Asset Flows & Trends Report [4] published by HedgeFund.net and Institutional Investor News estimates total industry assets reached $2.68 trillion in Q3 2007.

Fees

Usually the hedge fund manager will receive both a management fee and a performance fee (also known as an incentive fee). Performance fees are closely associated with hedge funds, and are intended to incentivize the investment manager to produce the largest returns possible.

Management fees

As with other investment funds, the management fee is calculated as a percentage of the net asset value of the fund at the time when the fee becomes payable. Management fees typically range from 1% to 4% per annum, with 2% being the standard figure. Therefore, if a fund has $1 billion of assets at the year end and charges a 2% management fee, the management fee will be $20 million in total. Management fees are usually calculated annually and paid monthly.
http://www.topratedforexbrokers.com/hedging/

Answer 6

Definitions of Hedge Fund on the Web:

Securities term that describes funds that use hedging techniques. For example, an option fund may use futures contracts on stock market indexes ...
pershing-cib.ibanking-services.com/mellon/invest_glosry_HHn.htm

An investment fund that attempts to generate active returns by employing long-short strategies and/or leverage.
www.nzsuperfund.co.nz/index.asp

A private investment partnership, owned by wealthy individuals and institutions, which is allowed to use aggressive strategies that are unavailable to mutual funds, including short-selling, leverage, program trading, swaps, arbitrage and derivatives. ...
www.comerica.com/vgn-ext-templating/v/index.jsp

a managed investment where the fund manager is authorised to use derivatives and borrowing with the aim of providing a higher return.
www.bt.com.au/About_Us/glossary.asp

Investment fund that not only buys financial assets (stocks, bonds, currencies) but also sells them short.
highered.mcgraw-hill.com/sites/0072973714/student_view0/glossary.html

A private investment fund or pool that trades and invests in various assets such as securities, commodities, currency, and derivatives on behalf of its clients, typically wealthy individuals. Some Commodity Pool Operators operate hedge funds.
www.cftc.gov/opa/glossary/opaglossary_h.htm

A private fund which usually solicits investments from wealthy individuals. It is unregulated as it's assumed that the investors are knowledgeable and realize the speculative nature of the fund. It usually invests in high risk, short term instruments in order to achieve above-average returns.
fxtrade.oanda.com/help/glossary/glossaryD_K.html

A private investment fund that uses high risk techniques such as short selling and derivatives to achieve a higher return. Maligned in some quarters because of the perception that some hedge funds have so much leverage their activitives can be detrimental to the global financial system.
edition.cnn.com/2006/BUSINESS/06/12/btn.terminology/index.html

is a special type of investment fund with fewer restrictions on the types of investments it can make. Of note is a hedge fund's ability to sell short. ...
www.ventureline.com/glossary_H.asp

is a private, unregulated investment fund for wealthy investors (minimum investments typically begin at US$1 million) specializing in high risk, short term speculation on bonds, currencies, stock options and derivatives.
www.halifaxinitiative.org/index.php/Glossary

A form of mutual fund used by wealthy individuals and institutions to engage in aggressive speculative activities prohibited to ordinary mutual funds. ...
www.larouchepub.com/other/2005/site_packages/strategic_bankruptcy/3221glossary.html

Hedge funds use a range of generally high risk investment strategies including arbitrage and short selling , they are frequently highly geared....more on Hedge fund
moneyterms.co.uk/d/

a broad category of portfolio, or fund, that seeks to reduce risk by transferring some of that risk to another investor. These types of assets will generally have a low correlation with equity or bond markets.
www.tdwaterhouse.ca/pcs/pic/glossary.jsp

A fund that may employ a variety of techniques to enhance returns, such as both buying and shorting stocks based on a valuation mode.
www.schaeffersresearch.com/schaeffersu/general/glossary.aspx

An aggressively managed fund portfolio taking positions in both safe and speculative opportunities.
news.firstdata.com/glossary.cfm

An aggressively managed fund that takes positions usually in speculative investments. Focuses on secondary opportunities and hybrids in the loan market.
glossary.reuters.com/index.php/Loan_Market

private investment partnerships (exempt from SEC rules for mutual funds). Normally hedge funds take aggressive, often speculative and leveraged investment strategies but that is not required to be a hedge fund. ...
curiouscat.com/invest/openend.cfm

A private investment pool for wealthy investors that, unlike a mutual fund, is exempt from SEC regulation.
www.fundcash.com/fc_glossary.htm

These are a subset of the alternative investment asset class. It can incorporate a wide range of investment strategies and instruments.
www.candela-capital.com/glossary.htm

An absolute return oriented investment fund which seeks to produce investment returns from a particular investment strategy, with the manager partly or mostly remunerated in the form of a performance fee. ...
www.maitlandgroup.com/default.aspx

Generally a pooled investment vehicle that is privately organized and administered by investment management professionals and not widely available to the public. ...
www.cmra.com/html/body_glossary.html

means a private or public pooled investment vehicle engaged in strategies to reduce market exposure and enhance the rate of return
www.pescara.ca/glossary.html

A loosely regulated pool of capital which tries to increase returns by using options, futures, leverage, short-selling, restructuring companies, and other means. These are volatile investments, and the average investor should not invest a large percentage of their assets in these funds.
www.yyconsulting.com/taxglossary

The collective investment fund that takes large and often leveraged risk, with the aim of earning high return.
www.emecklai.com/mecklai/newweb/topbanner_links/Learning_Center/Glossary.asp

A strategy to reduce or offset investment risk using derivatives.
www.pic-uae.com/glossary/default.html

a flexible investment company for a small number of large investors (usually the minimum investment is $1 million); can use high-risk techniques (not allowed for mutual funds) such as short-selling and heavy leveraging
wordnet.princeton.edu/perl/webwn

A hedge fund is a private investment fund charging a performance fee and typically open to only a limited number of investors. Hedge funds are largely open to accredited investors only. They have grown in the public securities and private investment markets.
en.wikipedia.org/wiki/Hedge fund