How Do Hedge Funds Make Money Out of Thin Air ?
“The number-one job of the hedge-fund manager is not to make sure that you can retire with a smile on your face — it’s for him to retire with a smile on his face.”
-Mark Cuban
To put it bluntly, a hedge fund is a collected pool of money that is allowed to invest in instruments not usually accessible to a normal individual with a low net worth.
They are slightly different in terms that they’re unregulated. Taking the example of pension funds which also manage people’s money. Pension funds have regulatory and ambitions or blocks in terms of being able to trade various instruments. On the other hand, hedge funds are completely uncontrolled in that respect they can do whatever they want to and so ultimately they are charged with taking people’s money and trying to increase its wealth.
So, a hedge fund is an embodiment of auxiliary investment that pools capital from individual or institutional investors to invest in multifarious assets, often relying on labyrinthine know-how to invigorate its portfolio and superintend risk. Hedge funds can invest in anything from real estate to currencies and other pinch-hitting assets.
How Are They Regulated?
Hedge funds are usually set up and run as limited partnerships(LP). This type of legal structure includes general partners(GPS) and limited partners(LPS). GPS is responsible for managing a given investment fund. They have unlimited liability.
They aren’t subject to strict regulations as they are not typically offered to the general public, instead LPS are restricted to qualified investors such as institutions and high net worth individuals.
These investors are generally expected to be more knowledgeable and able to take higher risks. The common fee structure of alternative investment funds includes a management or base fee and an incentive or performance fee.
What do hedge funds invest in?
Hedge funds are conventionally seen as bellicose and dicey, exceptionally when juxtaposed to mutual funds.
Hedge funds contrive palpable trading manoeuvres, such as shorting stocks or ‘hedging’ themselves by going long.
Hedge funds invest in anything ranging from land, real estate, currencies, derivatives to other alternative assets. The only thing inhibiting the purview of any hedge fund is its directive.
Hedge Fund Types
Since hedge funds are private investment elements, they can do more or less whatever they like so long as the investors know their strategy beforehand. While this degree of free rein can prove devilishly risky, it also purveys hedge funds a huge amount of resilience.
Hedge fund are predominantly categorised as:
- Global Macro: Rather than analyzing specific companies, they look for opportunities arising from global economic and political events.
- Equity: They use the strategies that involve taking long and short positions in public equities in related derivatives.
- Relative-value: Their nucleus is on taking long and short positions in related securities and profiting from a stopgap divergence in their anticipated price relationship.
- Activism: They are based on various corporate actions such as mergers acquisitions or restructuring, they entail taking long or short positions in equity or debt securities of the companies involved.
Final Words
These investment vehicles deploy a variety of strategies such as the use of leverage and taking short positions.
Their traction is often imputed to the US bull markets of the 1920s, precedent to the great depression. Today, hedge funds have several trillion dollars under governance.