Your Guide to Hedge Fund Investments

If you are wondering, “What is a hedge fund?” then it is worth knowing that hedge funds are a form of investment that is generally only available to investors that meet accredited investor or sophisticated investor qualifications. To be considered an accredited investor, an investor must generally meet income or net worth related requirements while a sophisticated investor must meet investment knowledge and experienced based requirements.

While you may be interested in ways to make additional earnings, hedge fund investments require strategies. Common hedge fund strategies include but are not limited to:

  • Long/short equity strategies, involving long and short positions in equity, generally investing in publically traded equity.
  • Credit funds, debt investments that are based upon lending inefficiencies.
  • Arbitrage, involving the exploitation of discernible price contrasts between closely related assets through the purchase and sale of investments.
  • Event driven strategies, which are similar to arbitrage, in which investments are used to exploit pricing inflation and deflation that occurs after a specific event, such as a merger or takeover.

Some of the largest hedge fund companies include Bridgewater Associates, AQR Capital Management, Renaissance Technologies, JPMorgan Asset Management and Two Sigma Investments.

What is a hedge fund?

Have you ever found yourself asking, “What is a hedge fund?” A hedge fund is a type of investment that are set up and organized through a limited partnership, investment advisor or a limited liability company. The hedge fund manager raises money for the fund from approved outside investors and invests the collected funds in a number of ways, such as stocks, bonds, real estate, gold and startups. Statistically, hedge funds have outperformed the market over the past 15 years.

When learning what is a hedge fund in simple terms, it is worth knowing that most hedge funds require investments to remain within the fund for a set period of time. Early withdrawals may result in fines or be denied altogether based upon a particular hedge fund. Profits from a hedge fund are generally paid out quarterly or annually.

The manager of the hedge fund is typically paid an annual percentage as well as a percentage of any profits that are earned over time. However, some hedge fund managers are paid through only a profit arrangement.

Hedge fund strategies can be very risky to investors, but these funds also offer a greater amount of gain compared to a number of other types of investment opportunities. While hedge funds have outperformed the stock market for a lengthy period of time, investments into a hedge fund are often required to meet large minimum dollar amounts, raising the risk of loss significantly.

If you are interested in hedge fund companies, it is worth knowing that most companies will only work with investors that are considered to be sophisticated or accredited. A sophisticated investor typically must meet knowledge-based requirements and must generally have the knowledge and experience necessary to understand evaluate the risks and possible gains of an investment.

Accredited investors are more common. However, to be considered an accredited investor, the investor must generally meet one of the following qualifications:

  • The investor must have a personal income of at least $200,000 per year or $300,000 per year if married for at least two consecutive years.
  • The investor must have a net worth of at least $1,000,000 or more as an individual or with a spouse, excluding the investor’s primary residence.
  • The investor must be a director, executive or partner of another person who is tied to the hedge fund, such as an employee or manager.

Therefore, most individuals will not be eligible to participate in a hedge fund.

What are some common hedge fund investment strategies?

If asking, “What is a hedge?” it is worth taking the time to review common hedge fund investment strategies in order to make an informed decision on whether to invest in a hedge fund.

One of the most common hedge fund strategies is the long/short equity strategy. This strategy is most often used for startup hedge funds and generally include withdrawal terms and penalties. The long/short equity strategy uses several fundamental techniques in order to make investment decisions. Funds are typically used for a number of investments.

Credit funds is another common type of strategy employed by hedge funds. Credit fund investments are typically based upon lending inefficiencies and are most active following economic recessions. Debt strategies include, but are not limited to:

  • Distressed debt, involving investments in bank debt, corporate bonds and stock companies that are in distress.
  • Fixed income, involving long-term governmental, corporate and bank bonds, convertible notes and capital notes.

Another common hedge fund strategy is arbitrage. Arbitrage strategies exploit observable price differences by concurrently purchasing and selling various investments. These strategies can often produce consistent returns and may offer less risk compared to other common strategies used by hedge funds.

While similar to arbitrage strategies, an event-driven strategy exploits pricing fluctuations that occur after specific corporate events. These events may include mergers or takeovers, liquidations, etc.

Hedge Fund vs. Private Equity Differences

When learning how to invest in a hedge fund, it is important to know the difference between a hedge fund and a private equity. A private equity fund involves the investment directly into companies by purchasing private companies. Private equity fund strategies commonly use leveraged buyouts as a way to acquire financially distressed businesses.

There are a number of key difference between a hedge fund and a private equity. For starters, hedge funds typically focus on liquid assets as investors can generally opt out at any time and cash out their investment. However, a private equity fund almost always requires investors to invest for a set period of time, often between seven and ten years.

Hedge fund strategies also often lead to higher risk compared to those used by private equity funds in order to achieve maximum short term profits. Private equity funds generally build return on an investments at a slower pace and are therefore able to reduce risk to investments.