Hedge Funds

Hedge Fund Overview

Passive income is one of the most important ways to build long-term capital. It includes investing money with banks, investing in the stock market, renting out your real estate, etc. But since the profitability of the bank deposits can’t even keep up with the inflation rate in the long term and real estate investments require additional expenses for repairs as well as personal time to find and manage tenants, investors most often turn to the stock market. The first investment funds were created a hundred years ago to free investors from having to constantly monitor their assets and enable investors to receive income that is truly passive. Today such funds are very popular and are used as tools for collective investment. A «Hedge Fund» is a type of an investment fund. Its structure has the greatest profit potential. However, it is not available to everybody. More on what hedge funds are, how to invest in them, and the returns you can expect is described below.

How They Make Money

Hedge funds – are financial firms that got their name because they can use any stock market instrument, including derivatives, covered in their investment mandate. That means that those funds can hedge their positions, that is, protect them from losing value. Today the term «hedge fund» has a wider application and usually refers to a fund with a proprietary or unique management strategy. This means that it takes advantage of various directions and different financial markets. Thanks to the proactive management strategy and risk management, the fund’s manager covers losses from some transactions with profits from others. Hedge funds accept investments from qualified high-net-worth investors. Most Russian and offshore funds set a threshold minimum of $100,000; US hedge funds require $5 million from individuals and $25 million from entities. Hedge fund profitability greatly varies and directly depends on the choice of strategy and market conditions. However, it should be noted that on average its expected return is much higher than that of the more regulated and «traditional» collective investment funds. Managers usually compare their financial results with a certain benchmark. For example, the most popular benchmark is the annual return of the S&P 500 Index. If the fund outperforms the index in a given reporting period, then the manager is considered to be doing his job well. However, some funds boast returns several times higher than the Index, which sometimes amounts to hundreds of percent per annum.

How They Work

Collective investment instruments involve discretionary management, that is, having invested their capital with the hedge fund, shareholders can no longer influence its placement. Managers build investment portfolios by independently executing buying or selling transactions in accordance with the fund’s investment mandate, which typically does not limit their choice of stock market instruments. The fund informs their clients of the results at predetermined intervals, usually every quarter. The fund charges a fee for its work, most often it is 2% of assets under management and 20% of profits.

Structure

Even though there is a great variety of funds, they have many common features in their structure.
We can highlight the following participants within various hedge funds:

• Fund Shareholder (Investor)
• Bank (Custodian)—holds the assets and securities and controls the activities of the fund
• Prime Broker Bank—manages assets and acts as a broker
• Manager (a group or an individual)—develops the strategy, makes investment decisions
• Board of Directors—monitors the fund’s operations
• Auditor—monitors the reports and accounting documents
• Legal Advisor—monitors contracts, legal documentation, etc.
• Administrator—this position requires versatility because this person oversees the accountants, lawyers and distributes payments.

Nearly all hedge funds have this type of structure.

Hedge Fund Types

The International Monetary Fund divides hedge funds into 3 categories:

• Global Funds execute transactions in different industries in any market in the world.
• Macro Funds operate within different areas of one country and take into account the specific directions of the country’s development.
• Relative Value Funds work with the stock market of a single country.

Today hedge funds are becoming more and more complex; they are developing more sophisticated methods. Some funds combine different strategies and create new ways to invest. Some start using new tools: algorithmic trading and special software that automatically executes transactions.

Russian Hedge Funds

Many investors in other countries look at hedge funds as a reliable investment. However, Russian investors have not yet had the time to thoroughly evaluate this method of creating passive income.

The number of hedge funds in the Russian Federation is still extremely small, and those that do exist are mainly the offshore type. Russians invest in mutual funds much more often.

How to Choose a Hedge Fund For Investment

If you have the necessary amount of cash available, investing in such a fund can be an excellent way to build your long-term capital. When conventional strategies fail and traditional investment portfolios are underperforming, a well-chosen hedge fund can provide great returns. When choosing a financial firm, you need to check the following points:

• Makes a profit regardless of the market conditions
• Has been making a profit for a long time
• Works only with highly liquid instruments

Some investors do not want to invest in hedge funds because of their high fees. In the long run, those fees can really pay off, thanks to high returns on investment and regular income regardless of market conditions.

Conclusion

Based on the above, investing in a hedge fund is an excellent investment opportunity with relatively low risk and high returns. These investments are not available to everyone but only to qualified investors with sufficient capital. When choosing a hedge fund, it is necessary to study the fund’s investment mandate and its regulation specifics. With those precautions in place, the investor has a great opportunity in the long term for a profitable return on their passive investment.