Hedge Fund Definition
Hedge funds are a portfolio of various investments that are managed aggressively, generally due to the strategies used. The main goal of such investments is to get higher returns compared to other investments. So basically Hedge Funds are privately owned companies that pool money from the investors to reinvest them in group of financial instruments to achieve higher returns.
Hedge funds are absolute return fund that invest within the financial markets in stocks, bonds, commodities, currencies, derivatives, or they may apply non-traditional portfolio management techniques like short selling, leveraging, arbitrage, swaps, etc.
Initially conceived in the US (1949), hedge funds flourished in the late eighties, and now form an integral part of institutional and private client portfolios.
Who can invest in a hedge fund?
Generally, hedge funds are most often set up as private investment partnerships which are open to a limited number of investors requiring a large amount of minimum investment. So, investments in Hedge funds are available only to sophisticated investors, such as institutions and individuals with substantial assets.
Generally an Accredited Investor, corporate treasuries, institutions, fund of funds, private banks, endowments, and pensions invest in hedge funds.
An accredited Investor can invest in the Hedge Fund. He must meet the following criteria for investing in a hedge fund–
- Has a net worth of more than $1 million, owned alone or jointly with a spouse
- Has earned $200,000 in each of the past two years
- Has earned $300,000 in each of the past two years when combined with a spouse
- Has some rational expectation of making the same amount in the future
For investment institutions, such as pensions, endowments, and trusts, the primary qualification is having $5 million in assets.
Minimum investment required for Hedge funds
The minimum investment required for investing in Hedge funds varies from fund to fund. Although some funds charge as low as US$10,000 but such fund is an exception. The common starting range would be between US$250,000-$500,000. Established funds may have much higher minimums requirements upto $10,000,000 or more, which can depend on the fund and manager.
Key features of hedge funds
Hedge fund managers chase absolute returns rather than returns comparative to an index or benchmark. This allows them to generate gains even when the traditional markets conditions are range bound or underperforming.
- Applications of Skill-based strategies
Skills of a Hedge fund manager play a key role in generating the returns by executing a specific chosen strategy rather than relying on asset appreciation in rising markets.
Hedge funds can be traded on the long and short side of various financial instruments.
Alignment of interest
Hedge fund managers frequently invest their own money, which bring into line their interests with those of their investors.
History of Hedge Funds
Hedge funds begun in the year 1949 when Alfred Winslow Jones started an investment partnership. This partnership regarded as the first hedge fund. But, remarkably many of the ideas and strategies that he introduced over fifty years ago remain vital to the hedge fund industry even today.
Jones, in the Hedge fund committed his own money in the partnership and based his compensation as a performance incentive fee, which was 20% of profits.
Then the industry was relatively quiet for two decades due to losses made in that period. But in the year 1986, yet another article in ‘Institutional investor’ caught the attention of the investors due to the double digit returns that the fund made.
But ‘Today’ the Hedge fund industry continues to thrive despite of the troubles. Modern funds have seen various returns, investment requirement changes, strategies etc.
Hedge Fund Fee Structure
Generally, compensation for a Hedge Fund Manager is of two types-
- Management fee
- Incentive Fee
A Management fee is usually a percentage of the size of the fund and an incentive fee is performance-based. Hedge funds typically charge a management fee of 2% of assets managed, but in some cases it can be even higher, if the manager is in high demand. Most hedge funds charge an incentive fee between 10-20% of profits.
Investment Strategies for Hedge Funds
1. Long Only
It is a strategy where a hedge fund owns long positions in stocks or other assets. This strategy basically looks for alpha to the upside to outperform their benchmarks. If the S&P 500 is the fund’s benchmark which is up 10%, and the hedge fund is up 15%, the extra 5% between the two is the alpha generated by the portfolio manager.
2. Short Only
It is a very difficult strategy. In this strategy the hedge fund only sells stock short.
It is a strategy where the hedge fund is long or it owns as well as sells stock short.
For example if there are stocks of ABC Corp (Long) and XYZ Corp ( Short) .Such a strategy gives exposure on both sides of the trade. The hedge fund exposure may be 70% long and 30% short for a net equity exposure of 40% (70% – 30%).
4. Market Neutral
Market neutral is a strategy accomplished in two ways. When there are equal amounts of investment in both long and short positions, the net exposure of the fund would be zero.
For example, if 50-50 percent of the funds are invested in long and short positions respectively, the net exposure would be 0%, making the gross exposure of 100%.
5. Equity Arbitrage
These funds are typically for takeovers, especially when they are done with stock or stock plus cash.
These funds firmly look for any item or news that can move the market. Such managers have computer programs which constantly scan for any headlines around the world. Even five seconds of lead time is important here. The moment when the fund has the data, it can short the S&P 500 seconds in front of the news, it can make handsome money.
7. Fixed-Income Arbitrage
8. Global Macro
Hedge funds using this strategy analyze how the macroeconomic trends may affect various factors like the interest rates, currencies, commodities or equities and take long or short positions in most sensitive assets.
Major Hedge fund companies in the world
- Bridgewater Associates
- Man Group
- JPMorgan Asset Management
- Brevan Howard Asset Management
- Paulson & Co.
- BlackRock Advisors
- Winton Capital Management
- Highbridge Capital Management
- BlueCrest Capital Management
Hedge Fund companies in India
- HFG India Continuum Fund
- India Deep Value Fund
- Fair value
- Atyant Capital
- India Capital Fund
Career in Hedge Fund
The career track of a Hedge fund Analyst includes-
1. Analyst- 2-3 years
2. Senior analyst- 1-3 years
3. Portfolio manager
The career track of a Hedge fund trader includes-
1. Execution trader- 1-3 years
2. Senior trader
Hedge Fund Salary
Compensation for an Analyst varies based on the fund and its performance.
Generally an investment bankers or MBA students with little or no prior experience is expected to earn upto $90,000-$120,000 (Subject to change).
Traders with little or no experience can expect a base of $50,000-$80,000 (Subject to change).
Essential steps to become a Hedge Fund manager
1. Be sure that working for a Hedge Fund is truly your passion
Learn about hedge funds as much as you can. If you really want to work for a hedge fund, it will be portrayed in your discipline, interacting, knowledge of the industry, passion and actions.
2. Become a Student of the Hedge Fund Industry
You may subscribe to hedge fund newsletters, reading books on hedge funds. Grab as much as information about the major players, important definitions, strategies etc.
3. Recognize your Career Mentors
You must try to identify your potential mentors who may help you and try to build relation with them.
4. Take Hedge Fund internships
Start looking for internships in Hedge funds
5. Identify your interest
At this stage you must be able to categorize
What type of job would you like?
- The types of responsibilities that you are looking forward to?
6. Find Job!!!
Find unadvertised job openings by either cold-calling companies or looking for such openings online.
Best routes for getting that placement are:
- Be in touch with the hedge fund professionals who graduated from your school
- You can also Join any Hedge Fund Group
- Receiving your CFA, CAIA or CHA title
- Attending various hedge fund conferences where you can connect with the professionals
Hedge Fund Queries
Hedging means managing or mitigating the risk. There are many innumerable investment risks like market, Interest rate, Inflation, Regional, Currency, etc. Hedge fund managers apply the complete resource of financial strategies to mitigate the above given risks.
Can hedge Funds not be hedged?
Yes, but this raises the question of how they can call themselves “hedge” funds. The answer is that some funds may be long-only in stocks, and may even use leverage which makes them speculative and unhedged.
Is every hedge fund aggressive?
The answer here is no, not all the funds are aggressive.Although there are some aggressive hedge funds, but there are also many others that clearly and systematically follow consistency of returns and/or conservation of capital.
What are offshore hedge funds and who can invest in them?
These hedge funds are registered in offshore jurisdictions. Such funds are designed to allow investment without being exposed to the rebukes of tax law in any given onshore legislations. Any qualified investor with offshore money can invest in such funds.
Are fees to be paid even if the fund loses money?
Yes, the management fees have to be paid but the incentive fees are applicable only after positive performance is obtained.
What is the meaning of Hurdle rate?
A hurdle rate is the minimum return that an investment must make before the application of incentive fees.
What does a lock up period in hedge fund means?
It is the time period to hold the assets within a fund before they are to be removed.