What are Hedge Funds? You know its a term you have heard, but do you know what it means? If you have any interest at all in the idea of investing – even if you haven’t ever ‘taken the plunge’ yourself yet – there is a very good chance that you have at least come across the term ‘hedge fund’. But many people don’t actually know what they are, who they are designed for and what potential benefits – and risks – they present for an investor.
What are Hedge Funds? – The Definition of Hedging
To understand hedge funds, it helps to understand the definition of hedging in the first place. Hedging is basically the act of attempting to reduce risk. You might have heard someone say they are ‘hedging their bets’, meaning that they are trying to minimize the danger of a bad outcome. And it means the same thing in the financial world.
What is a Hedge Fund?
In the most basic terms a hedge fund makes use of a wide range of investment methods and invests in a wide array of different assets in an attempt to generate a higher than usual rate of return than more standard investments might. This means that usually a hedge fund is a riskier investment than most, as a bigger payoff will almost always call for such things. Investors buy shares in the fund and then assume a portion of the risk as well as the potential benefits.
Who Controls a Hedge Fund?
A hedge fund is controlled by a hedge fund manager. It is that person’s almost sole responsibility to decide the best ways for the fund to make money while also determining how the risks involved in doing so are kept to a minimum. It’s a very difficult balance to maintain and requires a great deal of financial expertise and knowledge, as well as something of a stomach for gambling. That’s why successful hedge fund managers tend to make a lot of money themselves – it’s a huge risk as a career move as well, but if they can pull it off, a very lucrative one.
Who Should Invest in a Hedge Fund?
Hedge Funds are a less usual investment tool, so are certainly not for everyone. Here is a little more to consider about who they are really for:
Someone who is an Accredited Investor – An accredited investor is a person meeting a certain standard of income and assets. This standard does vary from hedge fund to hedge fund but is often quite high.
Someone Willing – and Able – To Take Big Risks – Money invested into a hedge fund is far from safe, so the person doing so has to be ready and willing to accept potential big losses in the pursuit of big gains.
Some Willing to Do Their Homework – An investor must be willing to spend time reading through all of a fund’s prospectus and related materials. And these are often long and dry documents that don’t make for exciting reading, but it has to be done. Not only do you need to know how investments will be made but also all of the fees that will be incurred and the restrictions on your rights to redeem your shares in the fund.
Someone Willing to Research the Hedge Fund Manager – The average hedge fund is only ever going to be as good as the person who will be managing it. While past performance does not guarantee future success if the person has a demonstrable good track record it’s an excellent sign.
Again, hedge funds are not for everyone, but for some it’s an investment worth considering at some point, especially for those looking for bigger returns. The best person to discuss them one on one with? A financial adviser, who can go into everything in detail and see how a hedge fund investment might work in a person’s unique investment plans.
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