Hedge funds can offer wonderful investment options to choose from for those who qualify.
Many people consider hedge funds to be secretive accounts that generate huge returns for only the wealthiest investors. While some truth holds for this, hedge funds are a lot more than that. They not only offer investors a great opportunity to employ some of the sharpest financial minds in the world, but they also allow investors to profit while others are losing money due to the freedom that hedge fund managers enjoy legally.
What Are Hedge Funds?
The definition of hedge funds can be extremely broad. They have long been considered as secretive high-return investment instruments available only to the wealthy, but they are actually more than that. Basically, they are privately operated funds that are managed by using nontraditional investment strategies as compared to a mutual fund. The term "hedging" actually means reducing risk, which is what hedge funds were designed to do originally. However, as time went on, they became more and more speculative in nature even though the name stuck.
Hedge Funds Are Lightly Regulated
One characteristic of hedge funds is that they are not required to be registered with the U.S. Securities and Exchange Commission (SEC). Nor are they required to be registered with either the National Association of Securities Dealers (NASD) or the Commodities Futures Trading Commission, which are the major regulatory bodies in the investment business. In spite of this, many hedge fund managers choose to register with these agencies anyway to give creditability to would-be clients. However, in return for this regulatory freedom, hedge funds can accept capital only from qualified investors. Qualified investors are defined as those with a net worth of at least $1 million or an annual income of $200,000.
Hedge Funds Can Use Aggressive Investment Strategies
The only way that hedge funds can achieve the high returns that many of them obtain is by having the freedom to use different investment methods from those of a traditional fund manager. This is one major advantage of having very little regulatory oversight. For instance, unlike mutual funds, a hedge fund manager can sell stocks short in a bear market, buy and trade futures as well as stocks and speculate in market derivatives. In addition, a manager can utilize maximum leverage by borrowing money at favorable rates for low-risk investments. All these factors help generate above-average returns.
Hedge Fund Management Fees
Another element of hedge funds that differ from traditional funds are the fees charged for managing the fund. Hedge funds typically charge clients an annual fee along with an additional bonus representing a percentage of the fund's annual profits. This is a great motivating factor for good money managers to start hedge funds as the SEC does not allow mutual funds to charge a performance fee. Although the levels of fees charged may differ among hedge funds, the structure of having a management fee plus a bonus fee rarely changes.
Investing In Hedge Funds
To become a part of a hedge fund, an individual first has to prove he is a qualified investor as required by the SEC. Some hedge funds have additional restrictions. The next thing he should do is find out the fund's investment strategy and decide if he is comfortable with the fund's objective. Also, a prospective hedge fund investor needs to find out what commitments the fund requires. Some funds require a client's capital to remain in the fund for several years before any kind of withdrawal. Finally, if a hedge fund manager is reluctant to freely provide information, then a would-be investor should move on to the next fund.
