Hedge funds: what are they and is it worth investing in them?

4 min read
Hedge funds: what are they and is it worth investing in them?
Picture: economist.com

Hedge funds take much more risk than most investment companies. Their income is higher than that of index investment funds, whose profits rise with market indices and fall with them.

Investors expect increased returns and minimal risk from hedge funds. They do not place assets in just one country and use all the opportunities to optimize taxation and other benefits by working in jurisdictions of different countries. There are about thirty hedge funds in our country.

What is a Hedge Fund?

A hedge fund is a legal entity that attracts investors’ money to invest it and make a profit, using hedging methods (insurance) against financial losses.

A hedge fund pools investors’ money to buy securities, and is similar to a mutual fund or equity investment fund. But hedge funds have more investment options.

The strategies used by hedge funds involve significant risk. They strive to make large short-term profits regardless of market conditions. This attracts investors who want to make a profit even in a bearish (falling) market.

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Hedge funds use the following aggressive investment strategies:

  1. Investing using “leverage” – borrowed funds, also called leverage.
  2. Debt investment by issuing long-term loans to enterprises or purchasing debt securities of enterprises or state and municipal securities.
  3. A game to reduce the price of shares – “short”.
  4. Arbitrage transactions.
  5. Purchase of real estate, art and currency – assets in which other funds do not invest.

Who manages the assets in a hedge fund?

A hedge fund manager is an investment manager who makes investment decisions on a daily basis. He chooses how to allocate the invested money and manages the risk level of the fund.

Hedge fund managers are motivated to succeed; they are paid a performance fee, which can be up to 20% of the fund’s profits if the fund is profitable.

How to invest in hedge funds?

In the West, hedge funds are viewed as an exclusive club that many investors want to join. The capital required to join a hedge fund in Russia is from one hundred thousand rubles. In foreign ones from hundreds to several million dollars.

Hedge funds
Picture: alpha-sense.com

In the United States, an individual must be an accredited investor to invest in hedge funds. As of 2019, only 4% of American households there earned more than the $300,000 needed to achieve accredited status.

In Russia, there are no such restrictions. To become an investor you need an initial contribution of about one hundred thousand rubles. You need to confirm the purity of the money being invested, attach a report from the bank where the investor has an account, sign the investment plan and leave the application in person or online. Wait for the hedge fund’s decision, which may not come soon. Sometimes a representative of a hedge fund himself comes to a potential investor for a personal conversation.

Is it worth investing in a hedge fund?

You don’t have to invest in hedge funds to grow your wealth. If an investor does not qualify as a hedge fund or does not have accredited investor status, the investor may use a hedge fund’s investment strategy or select mutual funds and equity funds that use strategies similar to hedge funds.

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It is beneficial to use long-term investment schemes. Investing in index funds during market declines allows you to purchase assets that have fallen in price and make a profit when the market rises.

If an accredited investor is willing to invest hundreds of thousands of dollars, or even millions, in hedge funds, it is a good way to diversify a portfolio and hedge against market volatility. But for someone looking for high returns, investing in index funds that track major indices such as the S&P 500 is likely to be a better option.

Disadvantages of hedge funds

Hedge funds are not as liquid as stocks or bonds, and they do not allow you to withdraw your invested money before a certain period of time. Hedge funds charge huge fees. Typically, hedge funds charge an asset management fee of 1% to 2% of the amount, plus a performance fee equal to 20% of profits.

These fees can eat up an investor’s entire income. This may not be a concern if the hedge fund is significantly outperforming the stock market indexes, but this is usually not the case. Sometimes it is more profitable to invest in index investment companies and mutual funds.

In a debate between hedge funds and investment funds, does this mean that hedge funds always lose? Not necessary. The goal of hedge funds is not necessarily to outperform stock indexes, but to provide reliable returns despite market fluctuations.

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