Hedge funds are professionally-managed investment funds that seek above
average returns through superior portfolio management.
The managers of hedge funds are usually paid on the
basis of investment performance.
Unlike traditional investment funds, hedge funds have the ability to generate profits in falling markets, to hedge
against adverse market, currency and interest rate movements and to generate profits from short-selling overpriced securities.
Short-selling involves the sale of a security that is not owned, but borrowed, with the view to generating a profit by buying the securities back more cheaply after the price has
fallen.
The first hedge fund was established in the United States around 50 years ago by Alfred Winslow Jones, an Australian who invested half his fund in shares expected to rise in value and half the fund was used to short-sell shares expected to fall in price - thereby hedging the portfolio against market movements.
When the stock market rose, shares owned by his fund made greater profits than the losses incurred on the shares sold-short, and when the market fell gains derived on the shares sold-short outweighed the losses incurred on the shares owned by the fund. The result was that his fund significantly outperformed all other equity funds in the United States for many years.
Hedge funds tend to be managed by investment professionals who have gained experience working for investment banks or traditional funds management firms.
The fund managers are motivated to generate attractive returns through performance fees and because many managers also invest a significant proportion of their own wealth into the funds they manage. The table below shows some general differences between a typical hedge fund and a typical traditional fund.
| COMPARISON
OF TYPICAL HEDGE FUND WITH TYPICAL
TRADITIONALLY-MANAGED FUND |
| Features |
Typical
Hedge Fund |
Typical
Traditional Fund |
| Able to invest in shares, bonds and derivatives |
 |
|
| Able to profit from owning cheap securities |
|
|
| Able to profit from short -selling expensive securities |
|
 |
| Able to reduce or eliminate market-related risks |
|
|
| Manager actively manages portfolio risk |
|
|
| Manager has own money invested in fund |
|
|
| Able to concentrate portfolio with large investments |
|
|
| Can use gearing or can fully invest in cash |
|
|
| Investment performance largely driven by |
Manager
skill |
Market
direction |
| Principal basis of manager remuneration |
Performance |
Fund
size |
| Fund performance assessed on |
Total returns and level of risk |
Returns relative to an index and similar funds |
Hedge funds have been increasingly popular with wealthy investors and overseas financial institutions that are concerned with the future market direction and looking for ways to diversify their portfolios and increase investment returns. The growth in hedge funds has been rapid in recent years:
| HEDGE FUNDS: NUMBER OF FUNDS & FUNDS UNDER
MANAGEMENT |
|
|
1988
|
1989
|
1990
|
1991
|
1992
|
1993
|
1994
|
1995
|
1996
|
1997
|
1998
|
|
Number
of funds
|
1,373
|
1,648
|
1,977
|
2,373
|
2,848
|
3,417
|
4,100
|
4,700
|
5,100
|
5,500
|
5,830
|
|
Funds
under management (US$ billion)
|
$42
|
$58
|
$67
|
$94
|
$120
|
$172
|
$189
|
$217
|
$261
|
$295
|
$311
|
| Source: Van Hedge Fund Advisors International |
 |
