Hedge fund
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A hedge fund is a private, actively managed investment fund that utilizes sophisticated strategies in international and/or domestic markets designed to offset losses during a market downturn and/or generate returns higher than traditional stock and bond investments. The first hedge fund began in 1949 and was designed solely to neutralize the effects of a bear market on an investment portfolio. However in modern times many hedge funds have become aggressively managed and may speculate in volatile assets such as foreign currencies and commodities, and aspire to accumulate capital gains based on future price movements. Hedge funds are privately managed, loosely regulated, utilize advanced investment strategies, have high management fees and are open only to qualified private investors or institutions. The hedge fund industry has grown rapidly in the past decades and is estimated to have $1.9 trillion in assets under management globally. Hedge funds utilize a wide array of investment strategies according to the goals of their managers and clients. Some investment strategies include Global macro, directional, event-driven, relative value (economics), and many others. Hedge funds are generally unsupervised by national regulatory agencies and, on occasion, have been accused of destabilizing various financial markets.
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Description
Hedge funds utilize a wider range of investment and trading activities than traditional long-only investment funds that invest exclusively in the equities and bonds. Hedge funds incorporate investment strategies aimed at securing positive returns on investment regardless of overall market performance. Hedge fund managers often invest their own money in the fund(s) they manage, which further aligns their interests with their investors. Investors in hedge funds typically pay a management fee that goes toward the operational costs of the fund, and an annual performance fee when the fund’s net asset value is higher than that of the previous year. Many hedge funds manage billions of dollars from large institutional investors, including pension funds, university endowments, and foundations. As of 2011, 61 percent of worldwide hedge fund investments were from institutional sources as of February 2011. As of 2009, however, hedge funds represented only 1 percent of the total funds and assets held by financial institutions. The estimated size of the global hedge fund industry is US$1.9 trillion.
Hedge funds are open to a limited number of accredited or qualified investors who meet a criteria set by regulators. Because hedge funds are not sold to the public or retail investors its advisers have historically not been subject to the same restrictions that govern other investment fund advisers, with regard to how the fund is structured and their strategies executed. However, hedge funds must comply with many of the same statutory and regulatory restrictions as other institutional market participants. Regulations passed in the United States and Europe after the 2008 credit crisis were intended to increase government oversight of hedge funds and eliminate any regulatory gaps.
Strategies
Hedge funds employ a wide range of trading strategies however classifying them is difficult due to the rapidity with which they change and evolve. However, hedge fund strategies are generally said to fall into four main categories: global macro, directional, event-driven, and relative value (arbitrage). These four categories are distinguished by investment style and each have their own risk and return characteristics. Managed futures or multi-strategy funds may not fit into these categories, but are nonetheless popular strategies with investors. It is possible for hedge funds to commit to a certain strategy or employ multiple strategies to allow flexibility, for risk management purposes, or to achieve diversified returns. The hedge fund’s prospectus, also known as an offering memorandum, offers potential investors information about key aspects of the fund, including the fund's investment strategy, investment type, and leverage limit. The elements contributing to a hedge fund strategy include: the hedge fund's approach to the market; the particular instrument used; the market sector the fund specializes in (e.g. healthcare); the method used to select investments; and the amount of diversification within the fund. There are a variety of market approaches to different asset classes, including equity, fixed income, commodity and currency. Instruments used include: equities, fixed income, futures, options and swaps. Strategies can be divided into those in which investments can be selected by managers, known as “discretionary/qualitative”, or those in which investments are selected using a computerized system, known as “systematic/quantitative”. The amount of diversification within the fund can vary; funds may be multi-strategy, multi-fund, multi-market, multi-manager or a combination.
Domicile
The legal structure of a specific hedge fund – in particular its domicile and the type of legal entity used – is usually determined by the tax environment of the fund’s expected investors. Regulatory considerations will also play a role. Many hedge funds are established in offshore financial centres so that the investor, rather than the fund, pays tax on the increase in the value of the portfolio. The investment manager, usually based in a major financial centre, will pay tax on the fees that it receives for managing the fund. It is estimated that around 60% of the number of hedge funds in 2010 were registered offshore, with the Cayman Islands accounting for 37%, the British Virgin Islands 7% and Bermuda 5%. Among onshore funds, Delaware (US) accounts for 27% and the EU (primarily Ireland and Luxembourg) accounts for 5%
Reference
1. http://en.wikipedia.org/wiki/Hedge_fund
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