Hedge Funds
A hedge fund is a pooled investment fund that holds liquid
assets and that makes use of complex trading and risk management
techniques to improve investment performance and insulate
returns from market risk. Among these portfolio techniques are
short selling and the use of leverage and derivative
instruments.
While most modern hedge funds are able to employ a wide variety
of financial instruments and risk management techniques,[5] they
can be very different from each other with respect to their
strategies, risks, volatility and expected return profile. It is
common for hedge fund investment strategies to aim to achieve a
positive return on investment regardless of whether markets are
rising or falling ('absolute return').
Hedge funds are considered alternative investments. Their
ability to use leverage and more complex investment techniques
distinguishes them from others. Other than a fund's regulatory
status, there are no formal or fixed definitions of fund types,
and so there are different views of what can constitute a 'hedge
fund'.
A hedge fund usually pays its investment manager a management
fee (typically, 2% per annum of the net asset value of the fund)
and a performance fee (typically, 20% of the increase in the
fund's net asset value during a year). Hedge funds have existed
for many decades and have become increasingly popular. They have
now grown to be a substantial portion of the asset management
industry, with assets totaling around $3.8 trillion as of
2021.[7] Hedge fund managers can have several billion dollars of
assets under management (AUM).
Hedge fund strategies are generally classified among four major
categories: global macro, directional, event-driven, and
relative value (arbitrage). Strategies within these categories
each entail characteristic risk and return profiles. A fund may
employ a single strategy or multiple strategies for flexibility,
risk management, or diversification. The hedge fund's
prospectus, also known as an offering memorandum, offers
potential investors information about key aspects of the fund,
including the fund's investment strategy, investment type, and
leverage limit.
The elements contributing to a hedge fund strategy include the
hedge fund's approach to the market, the particular instrument
use, the market sector the fund specializes in (e.g.,
healthcare), the method used to select investments, and the
amount of diversification within the fund. There are a variety
of market approaches to different asset classes, including
equity, fixed income, commodity, and currency. Instruments used
include equities, fixed income, futures, options, and swaps.
Strategies can be divided into those in which investments can be
selected by managers, known as 'discretionary/qualitative', or
those in which investments are selected using a computerized
system, known as 'systematic/quantitative'. The amount of
diversification within the fund can vary; funds may be
multi-strategy, multi-fund, multi-market, multi-manager, or a
combination.
Sometimes hedge fund strategies are described as 'absolute
return' and are classified as either 'market neutral' or
'directional'. Market neutral funds have less correlation to
overall market performance by 'neutralizing' the effect of
market swings whereas directional funds utilize trends and
inconsistencies in the market and have greater exposure to the
market's fluctuations.