Last Updated on April 7, 2021 by John Fischer
Hedge funds are an alternative investment tool that aims to maximize the investor’s returns while also eliminating risk regardless of what the market situation is.
Today we will help bring some clarity for everyone to understand exactly how they work and what they are so you can diversify your portfolio effectively.
What are Hedge Funds?
Hedge funds have been in the industry since 1969 and there are over 10,000 available to date.
A hedge fund can be described as a pool of funds that individuals or institutions pool together to invest in multiple assets. The initial funds are raised by this group of people and they are expected to make it big in the market. Ultimately, the hedge funds are open for others to participate, invest in and make profits together.
How do Hedge Funds Work?
Hedge funds invest in various categories of securities such as stocks, bonds, and commodities. The techniques involved are risky but sophisticated. They are said to have an estimated accumulated (global) value of $3 trillion and are not regulated by the SEC.
The main objective is to reduce the risks of an unpredictable financial environment and increase profits in the longer run. A hedge fund manager makes money by cashing in on the money others have invested in.
For example, a company called Happy Tails Investments runs a hedge that is open to investing anywhere in the world. The company has stated that it will receive a 30% cut on profits over 10% in their operating agreement. Now, five investors hoping to invest in Happy Tails Investments roll in 30 million each in investment. Happy Tails begins with $150 million in funds. It later makes a profit of $100 million, making the total assets valued at $350 million. As per the agreement, each investor will benefit from their 10% share of the $350 million, which is called the hurdle rate. The amount that is left is later split in an 80-20 ratio between the investors and the firm.
Hedge Funds are not for everybody, so in order to invest, you need to have a net worth of $1 million at least. With hedge funds, you can invest in real estate, currencies, stocks, bonds, and other asset types; the possibilities are unlimited with no restrictions.
They definitely serve a need, but they might not be your cup of tea if you are an average investor. It would be best if you did thorough research before investing. We would recommend that you connect with a professional to help you with the process.