Hedge Funds

What are Hedge Funds?
Hedge funds are private pooled investment limited partnerships which fall outside many of the rules and regulations governing mutual funds. Hedge funds therefore can invest in a variety of securities on a leveraged basis. Today, the term hedge fund refers not so much to the hedging techniques hedge funds may employ as it does to their status as private investment partnerships. There are other unregistered pools of investments that are similar to hedge funds such as venture capital funds, private equity funds and commodity pools which are not categorised as hedge funds.
Some of the key characteristics of hedge funds include:
- Exemption from many of the rules and regulations governing mutual funds. Hedge funds therefore are not required to meet disclosure requirements and are prohibited from public advertising and soliciting investors directly or through a registered broker-dealer.
- Flexibility in their investment options. Hedge funds can use short selling, leverage and derivatives. This enables them to deliver non-market correlated returns
- Wide dispersion in investment returns, volatility and risk
- Linking compensation to performance with compensation of managers based on a percentage of the hedge fund’s capital gains and capital appreciation. In addition, hedge fund managers often invest their own money in their fund.
Difference between hedge funds and mutual funds
Hedge funds have a structure similar to mutual funds in that they are both pooled investment vehicles that accept investors’ money and invest it on a collective basis in publicly traded securities. There are, however, many important distinctions:
- Mutual funds are highly regulated and restricted in the variety of investment options. Hedge funds are less regulated and therefore have a wider range of investment options.
- Mutual funds are measured on relative performance such as a market index or other mutual funds. Hedge funds are expected to deliver absolute returns.
- Hedge funds are often specialised and operate within an industry or speciality that requires a particular expertise- Mutual funds remunerate managers based on percent of assets under management. Hedge funds remunerate managers with performance related investment fees. Hedge fund managers typically charge a 2% basic fee plus a 20% performance fee. Fund of hedge funds operators typically charge an additional 1.5% in basic fees and up to 10% in performance fees.
- The future performance of mutual funds is dependent to a greater extent than that of hedge funds on the direction of equity markets.
- Hedge funds have much larger minimum investments (average $1m) than mutual funds. Usually very little of the investment manager’s own money is invested in mutual funds.
- While mutual funds are available to the general public, hedge funds usually face many restrictions in selling their product. In the US, for example, an individual needs to be an accredited investor (annual income over $200,000 or net worth over $1m) in order to invest in a hedge fund.

Source: Hedge Fund, City Business Series-International Financial Services,London