What is a hedge fund?
What is a hedge fund? It’s an investment fund that uses higher-risk/higher-reward strategies.
The term ‘hedge fund’ goes through polarised periods of recognition. Sometimes, they’re all anyone can talk about in business. Most other times, they operate under the radar, employing their own unique business structures and investment strategies.
What is a hedge fund?
A hedge fund is a type of investment fund. It has the following distinguishing characteristics:
- It’s a partnership of multiple private investors.
- It employs several higher-risk/higher-reward strategies to make money.
- The minimum amount invested by each contributor is usually relatively high.
- For that reason, it usually only attracts high-net-worth individuals.
Why are they called hedge funds?
The name comes from their tactic of creating “hedged bets” – or bets that limit overall risk. They do this by investing some assets directly against the fund’s area of focus. That way, any losses are covered… at least partially.
What are the advantages of hedge funds?
Hedge funds typically offer greater returns than other kinds of investing. The people running them often have years of experience and enough capital to finance the operation.
The other significant advantage is that hedge funds are generally less regulated than other investment funds. This means they have greater freedom to invest in areas where they see potential profit, regardless of the risk to stakeholders.
What makes hedge funds hedge funds?
Hedge funds use strategies like leveraged assets, derivatives, and equity. This kind of activity could reap huge rewards, but it could also fail spectacularly.
For this reason:
- Hedge fund investors are usually known as “accredited investors”. They have earned the power to trade unregulated securities because of their income, net worth, governance status, track record, or a combination. In other words, there is experience behind the wheel.
- Given the amount of capital needed to start the process, they are usually only open to high-net-worth individuals.
Do hedge funds come in different types?
Yes. The differences are driven by the strategy each type uses. There are several strategies, so we’ll only give you the basics in this article. You can find the finer details here.
What should boards know about hedge funds?
It’s always important to know just who is investing in a company. So, if you’re a director, make sure you’re aware if a hedge fund has bought some of yours.
Some hedge funds buy and sell securities as part of broader investment strategies; the impact felt at the board or management level could be next to nothing.
However, others might have a more substantial impact – such as activist hedge funds. These will usually buy stock in a business because they believe they know how to boost its stock price. In general, this kind of thinking isn’t good news for directors or executives because a change in management might be coming.
You can read more about activist investors here.