Everyone has most likely heard of hedge funds, but many don’t know just how influential they are. Hedge Funds manage nearly $2 trillion of assets globally, a large chunk of change no matter how you slice it.
Hedge funds are portrayed in the media as being volatile, and sometimes detrimental vehicles for investors. Still, not much is known about hedge funds and how they work. It appears, though, that billions of dollars are pushed through these funds each year, and massive profits are generated even in the worst of economies. Are these hedge funds just run by investing geniuses, or do they involve a magic crystal ball that can help in making stock picks?
Obviously there are no crystal balls or sure-fire avenues to success in this world. That said, it certainly doesn’t hurt that hedge funds are run by some of the most astute and professionally trained investors in the world. When it comes to hedge funds, the money is there. The profits are there as well, or else organizations wouldn't continue to throw their millions into the hands of these hedge fund managers and companies. These investors who run hedge funds eat, breathe, sleep, and dream the market. They are constantly on that grind looking for the next thing to invest in, and they are relentless.
Hedge Funds Are Not Regulated By The SEC
An important thing to know about hedge funds is that they are not regulated by the SEC. This gives hedge funds many more liberties than mutual funds or index funds. This deregulation gives hedge funds the ability to move quickly in markets and strike when the iron is hot without taking a second thought to what type of trades they may be taking part in. This allows as well for hedge funds to be non disclosive about their portfolios and trades.
While hedge funds have certain luxuries by not being regulated by the SEC, there are downsides to their funds as well. The investors who are able to invest in these hedge funds are very selective. Hedge funds can't just take money from the general public. Hedge funds also cannot market themselves the way that hedge funds do.
When you are reading financial magazines, you are bombarded by an array of different advertisements promoting different mutual funds, but you will never see any ads promoting hedge funds. They way they raise their money is much different. Usually these hedge funds are funded by high end investors, trusts for universities, and other endowments.
How Do Hedge Funds Make Money?
Hedge funds make their money just like a broker or a mutual fund would make money, with management fees. However, these management fees are larger than most mutual funds. The management fees are specific to each hedge fund, but they are a reason why hedge fund managers enjoy being in the business of hedge funds instead of mutual funds.
Many financial protégées will decide to work in the world of hedge funds due to the amount of money that they will be managing. It is normal for hundreds of millions of dollars to be traded in a single hedge fund, and with this kind of money being traded, hedge fund managers get amazing management bonuses.
Another difference of hedge funds vs. mutual funds is that hedge fund managers get a percentage of the profits from the hedge fund trades each year. These percentages can go up to even 50 percent at times, but usually the standard percentage of profits that hedge fund managers see is about 20 percent. This motivates hedge fund managers to get as much profit as they can out of their hedge fund. On the down side, there is no percentage of the losses that come out of the hedge fund managers’ pocket either. For the manager of the fund, this is a pretty great deal.
Are Hedge Funds Bad?
Many individuals may have a poor perception of hedge funds due to the way that they are portrayed in the media and in Hollywood. It is better, however to base your opinions of good and bad off of the realities. One of the reasons that hedge funds may get a bad rap is that Hedge Fund Managers take bigger risks. They are putting the fund’s money on the line, but they aren't accountable for losses.
What people must understand is that most of the time hedge fund managers also have some of their own skin in the game. It may seem on the outside that hedge fund managers don't care about losses, but with their own money invested, they are usually fairly calculated with the risks that they take.
Another knock against hedge funds’ rep is the secrecy that surrounds them. Because hedge funds are not regulated by the SEC, they have no requirements to disclose how their clients’ money is being invested. Hedge fund managers could really be doing whatever they please with the money, and they would not have to disclose any of this money to the endowments that have funded so much of this hedge fund.
When it comes to a hedge fund, things are so fast-paced that this secrecy can, at times, be a good thing. When decisions need to be made in the blink of an eye, there isn't time to appease clients with these high risk situations. The trigger needs to be pulled, and this non-disclosure gives hedge fund managers the ability to make decisions quickly when the trades need to be made.
What Do Hedge Funds Invest In?
A big part of how hedge funds make their money is with options. Options are basically betting on the future of a stock. You can either bet that a stock is going to go up, or that the price is going to go down. Say that you bought an option for $50, and said that your stock would go up by 1:30 tomorrow. If the stock goes up, you will gain an additional $50, making your investment now worth $100. On the other hand, the stock could go down and you would lose your $50. This is a very basic explanation of what hedge funds do a much bigger scale.
One way that hedge funds make a lot of their money is by investing in anticipation of big events. They take advantage of mergers, public offerings, new technology unveilings, and a wide range of other financial events. Hedge funds also invest in deeply discounted stocks. Deeply discounted stocks can be found during talk of bankruptcy in a company. This is a risky situation, but when a stock recovers from bankruptcy and the company goes on to be successful, the profits can be extreme.
Benefits Of A Hedge Fund
There are some great benefits to investing in a hedge fund. Usually hedge funds are secured with enough options and derivatives that it can perform well even during a down market. Therefore, including a hedge fund in an investment portfolio increases gains and limits risk of loss. Hedge Funds are great for long term investing, as they do not usually correlate with complicated entry and exit times.
Hedge funds are designed to be able to perform well in virtually any market conditions, so this makes it great for those who just want to put their money to work for a long period of time and not have to look at it. It doesn’t hurt that hedge funds are managed by some of the top investors in the world. To manage a hedge fund, a person needs to have a plethora of different certifications. Perhaps unfortunately, investing in a hedge fund is largely exclusive to the investing elite –which could be why it’s such an influential player in the world of finance.