High Risk Investments, A hedge or garden enclosure is referred to in English as a “hedge”. The verb “to hedge” also means “to hedge” in a figurative sense. Nevertheless, nothing would be more wrong than to assume that hedge funds are primarily intended to provide protection – the opposite is often the case. In fact, hedge funds are highly speculative and therefore risky for investors. In this article we explain what hedge funds are.
Hedge funds are a special type of investment fund that specifically pursue speculative investment strategies in order to achieve above-average profits that are well beyond the market average. The risk diversification that is otherwise common with funds takes a back seat. For the targeted investment success, financial instruments, securities and investments are used that are subject to more or less strong price or value fluctuations, such as stocks, currencies, raw materials or precious metals and related derivatives .
Leverage investments are a core principle of hedge funds in order to increase the potential for profit opportunities. Leverage can be achieved, among other things, with derivatives or with loan financing of investments. Another technique used by hedge funds is short sales – that is, highly speculative and risky sales of assets that are not owned by the fund at the time of the transaction and should only be acquired or closed out later in order to generate potential profit.
GOOD TO KNOW: “Hedging” basically means that a market participant protects himself against negative price developments.
In the context of the general definition of hedge funds, there is a large variety of funds with different assets and strategies. We will present the most important strategies in the course of the article. What they all have in common is the goal of above-average performance. Hedge funds do not measure themselves by market success. Or to put it another way: You are not pursuing a benchmark approach, but want an “absolute return”, i.e. the largest possible profit that is independent of the market.
Why is it called a hedge fund?
On the one hand, hedge funds typically use derivatives, which can also be used for hedging purposes. On the other hand, the funds themselves operate to a limited extent as part of their business. But that does not change their speculative character.
GOOD TO KNOW: There are currently more than 3,000 hedge funds active worldwide with an estimated investment volume of over three trillion dollars.
Hedge Funds And “Normal” Mutual Funds – An Overview Of The Differences
Hedge funds: Limited regulation only. “Absolute return” aimed for (= maximum possible profit). There are hardly any restrictions on investment policy, and fund managers are largely free to make decisions. Risk diversification is not the focus. Leverage through borrowing (outside capital) possible. Hedge funds use short sales. Opportunities and risks largely determined by the “quality” of the fund manager and the skill of the fund management, comparatively low market influences. Usually construction like closed-end mutual funds. High equity stakes required. Greatly limited availability, as – with a few exceptions – the shares are not listed on the stock exchange
“Normal” investment funds: Strong regulation and financial supervision. Aiming for a better result than the benchmark for active funds, only index replication for passive funds. The investment policy is determined by the purpose of the fund, as shown in the sales prospectus. Principle of risk diversification. Borrowing is only possible within narrow limits, leverage is in fact excluded. No short sales. In terms of performance, the development of the relevant market plays an important role because of the benchmark orientation. Open-ended investment funds: small units can be purchased and returned at any time or traded on the stock exchange.
What are fund of hedge funds?
A hedge fund is that invests in various hedge funds. In this sense, it acts as a “Fund Of Funds”. The subfunds or target funds can pursue similar, complementary or different hedge fund strategies. A maximum of 20% of the fund of funds assets may be invested in a single hedge fund. That should guarantee a certain minimum spread.