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About
Hedge Funds |
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Frequently
asked questions
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Are hedge funds risky?
Contrary
to popular misconceptions, the majority of hedge funds are not risky
investments.
The
first hedge funds were, as their name suggests, designed to
reduce market risk through the use of "hedging"
techniques. For example,
an equity hedge fund owning a portfolio of shares may enter
into futures contracts that provide a profit when the stock
market falls - this hedges the shares against market movements
and portfolio performance will be determined by the returns of
the shares relative to the index. Today, whilst some hedge funds (like the shares of some
individual companies) can be extremely risky, the vast
majority of funds that make up the hedge fund universe are risk averse and it is these funds that have
attracted most money from investors.
In many cases, the hedge fund managers invest a large
proportion of the own personal wealth into the funds they
manage.
Research on hedge funds shows that, on average, investing in hedge funds
is less risky than investing in a well-diversified portfolio
of shares. This
is because most hedge funds use some form of hedging technique
to remove or reduce market risk.
A portfolio of shares or bonds, on the other hand, will
rise and fall in line with the market and history has shown
that these markets can decline in value sharply and for sustained
periods and financial markets can also display periods of significant
volatility.
Why have hedge funds received negative publicity?
Unfortunately, hedge funds only receive media attention
when something bad occurs, such as when a hedge fund goes out
of business or its investors lose money.
This is because these stories are more newsworthy than
reports on the large number of hedge funds that significantly
outperform major market indices with lower risk than these
benchmarks. Mainstream
media also fails to report on the relatively unexciting
absolute return strategies that produce consistent returns of
12-25% a year, regardless of market conditions.
The media also likes to focus its attention on the activities
of large, high profile hedge funds such as George Soros’
Quantum Fund which make large leveraged bets on the direction
of currencies, interest rates, shares and commodities.
Fortunately, such hedge funds are not representative of
the hedge fund industry as a whole and 98% of hedge funds are
small, specialist funds that concentrate on a particular
narrowly-focussed investment strategy.
Many hedge funds only use derivatives for hedging
purposes and many hedge funds may not use any leverage at all.
What
is a fund of funds?
A "fund of funds" is simply a fund that invests in a
number of hedge funds.
There are many benefits to a fund or funds approach to
investing in hedge funds.
The most important benefit is that through the blending
of different hedge funds, strategies and asset classes, the
fund of funds manager aims to provide more stable long-term
investment returns than any of the individual funds.
Returns, risk, and volatility can be controlled by
through the mix of underlying strategies and hedge funds.
Additionally, because most hedge funds have high minimum
investments (US$500,000 or more) a fund of funds is used by
many to diversify their assets across a group of talented hedge
fund managers without having to meet the minimum investment
requirements for each individual fund.
The most compelling advantage of a fund of funds is that one's
capital is managed by a professional hedge fund investor who
has the ability and contacts to find, evaluate and manage the
best hedge funds and fund managers.
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