What is a Hedge Fund? Types, and Strategies

Hedge Fund

Introduction:

A hedge fund is an actively managed investment fund seeking attractive absolute returns. In pursuit of their fundamental return objective, hedge funds use various investment strategies and tools. Hedge funds are designed for a small number of large investors, and the fund manager receives a percentage of the profits earned by the fund, initiating a quick cash loan

History of Hedge Funds:

After the market crash of 1929, a reporter named Alfred Winslow Jones published an article in the late 1940s pointing out the lower returns for investors. He pointed out that investor could boost their returns if they start implementing hedging as their strategy in their investment. Later, Alfred Winslow Jones formed an investment partnership with A.W. Jones to implement the hedging strategy into his investment. This is known as the inception of a hedge fund.

Hedge Fund Strategy:

There are two types of investment strategies:

  • Active investment management.
  • Passive investment management. 

This is also known as core-satellite management, in which core refers to passively managed funds and satellite refers to actively managed funds. Hedge Funds strictly follow an active investment management strategy to maximize their returns. Hedge Funds exceed Private Equity in managing funds actively. In this, the return targets are unrelated to the index return targets. Hedge Funds manager do not weigh their stocks as per their weightage in the index. Here, managers may times keep cash holding, use leverage, quick cash loan, sell short or use specific strategies.

Manager selection for managing Hedge Funds:

Selection of a Hedge Fund manager is the most critical aspect of Hedge Funds as all managers come with different managing psyches and should match our investment psychology.

There are two types of analysis involved in the selection process of a Hedge Fund manager

  1. Qualitative Analysis:

In qualitative analysis, the following risk parameters are looked at:

  • Personal Risk: This thorough research is done regarding the background of all managers for selection. This contains their education. Their former employer, their clients, etc.
  • Administrative Risk: In this, checks regarding audit and controlling demands are made. This includes the registration process, auditing, individual pricing, etc.
  • Management Risk: In this, an analysis is to be done regarding proper risk management systems.
  • Portfolio Risk: In this, analysis regarding their liquidity, leverage, market risk exposure, etc., is to be carried out
  • Quantitative Analysis:

In qualitative analysis, the following risk parameters are looked at:

  • Performance Database
  • Screening
  • Performance Analysis

Hedge Fund Portfolio Construction Parameters:

The portfolio optimization strategy used traditionally is different for hedge fund portfolios.

The following aspects are primary drivers in the process of constructing a hedge fund portfolio:

  • Top-Down Allocation View
  • Quality of Fund
  • Value at Risk
  • Systematic Risk

Conclusion:

This partnership was formed worth $ 100. The strategy implemented by them

back then is popularly known today as a long/short equity strategy.

In this strategy, they invested in individual stocks taking either a long position or a short position based on the analysis of stocks. The overall portfolio can be either long, short, or neutral. In this way, they leveraged to increase their returns.

FAQs:

Q. Who typically invests in hedge funds? 

Institutions, corporate treasuries, endowments, funds of funds, family offices, private banks, and pensions often invest in hedge funds.

Q. What is the minimum investment?

The minimum investment amount varies for every fund. The minimum for established funds might be substantially greater, depending on the fund and management.

By kazim kabir

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