What is a Hedge Fund in Simple Terms
A Hedge fund is a special type of investment where capital is pooled (taken) from accredited investors or institutions and strategically invested in vast assets with a well-planned risk management technique.
To further explain, the funds are gotten from a partnership between interested investors (limited partners) and managed by the general partner or funds manager. The fund’s manager manages the funds according to a laid out strategy while the partners contribute the funds. The whole idea is to maximize returns eliminating possible risks along the way.
Key Features of a Hedge Fund
- The funds are open to a selection of accredited investors with an annual income of $200,000 and above or a net worth of $1 million. With such portfolio, the SEC allows some regulatory gaps to the investors who qualify to handle any potential risks.
- With hedge funds, you potentially have unlimited investment reach. Its mandate only limits hedge funds. So a hedge fund can literally invest in anything ranging from real estate to stocks, currencies, etc.
- Hedge funds use leverages like loans to achieve a positive return on investment notwithstanding how the market is faring.
- Hedge funds pay its funds’ manager an annual management fee and a performance fee in the ratio of 2:20. 2% as a management fee and 20% as commission on profits at the end of the year.
How to Pick a Hedge Fund
Choosing a particular hedge fund to invest in becomes a problem if you as an investor fail to streamline your due diligence process to your particular portfolio. They are 100s of viable hedge funds looking for investors, so it is important you identify the specific metrics that marches your plans. Here are a few guidelines to consider:
- Absolute performance: as an investor, you should first of all check the annual rate of return for any hedge funds you are considering. This will help eliminate underperforming funds and give you a clearer idea of where to look. Also, it’s important to note that a high performing fund in terms of returns does not necessarily mean the fund is great. It is imperative you scrutinize the fund’s strategy and compare with its competitors with same strategy and category.
- Relative performance guidelines: this will help you in your search for attractive funds with strategy – specific guidelines. Apps like Morningstar is great for this to help identify target funds using similar strategies.
To read more on the guidelines to follow while choosing a hedge fund click here
In conclusion, the operation of a hedge fund requires qualified professionals and thorough research of the market. This article is just an introduction to the operation of a hedge fund. Your inputs will be much appreciated, kindly leave a comment and help share this post.