When it comes to what hedge fund means, it can be quite difficult to explain exactly what it is. Certainly, in many cases you will find that no hedging techniques have been used. Instead, what you will find is that the various different hedge funds now available will use a variety of different strategies in order to make a profit for those who invest in them.
Most hedge funds today have been set up as a partnership and will consist of only a couple or a number of partners in it. As with all partnerships, there is a general partner and it is this person who manages the funds portfolio for the rest of the partners who have elected to invest in it. The fund manager almost always has his own money invested as well, giving him further incentive to ensure the fund provides good returns. It is the role of the general partner to make decisions with regards to what kinds of hedge fund investing is carried out.
The role of the hedge fund manager is to actually produce targeted returns or an absolute performance for the portfolio no matter what is happening in the financial markets. As mentioned previously, these people will use a wide range of trading strategies to ensure that the portfolio makes sound investments at all times. Some will use equity, others a fixed-income, whilst others may use CTA portfolios or mathematical algorithms to produce the right sorts of returns. Unlike mutual funds however, a hedge fund manager typically is one of the investors with his own investment as part of the total capital.
Just like any other kinds of investments, those who manage a hedge fund are subject to the same financial rules and regulations, as are other traders. However, when it comes to the strategies that they employ you will find that these kinds are not so easily accessible to others who manage regulated investments such as mutual funds, so there is a higher amount of risk to the investment a person makes, although the rewards are also greater.
For a manager of a hedge fund to see any kind of absolute return on the investments that they make they need to be flexible. This is one of the reasons why they will incorporate or use different investment strategies or techniques in order to achieve their goals. Below we look at some of the kinds of techniques that these kinds of fund managers will employ.
1. Short Selling - A hedge fund manager will select to sell a security that they do not actually own in order for them to then purchase it back at a later time for a price less than what it was originally sold for. If they do this properly, they could end up making a considerable profit on the initial investment that they made.
2. Arbitrage - With this particular technique, the hedge fund manager will buy and sell the same investment to a number of different markets at the same time. When carried out correctly the manager of the fund that they have made a reasonable amount of profit because of the difference between the prices that they brought and sold the investment for.
As well as the two hedge fund techniques mentioned above that can be utilized in this kind of investment there are also hedging and leveraging as well. With hedging, the manager of the fund will buy or sell a security so that they can use the funds to help offset against any potential loss the investment may otherwise have made. As for leveraging, this is used when the manager has to borrow money in order for them to invest in a particular financial product.
Read: Hedge Funds For Dummies (For Dummies (Business & Personal Finance))
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