What is a hedge fund?
What are hedge funds? A hedge fund meaning comprises a private pool of funds that involves different investment strategies to gain profits. It is a collective endeavor of investors who aspire to earn high profits. There is no well-defined set of regulations to process hedge funds. All the terms and conditions are defined by the partners collaborating to acquire profits through hedge fund strategies.
Common hedge fund strategies
What do hedge funds do? They are financial partnerships that utilize pooled funds for the purpose of earning a positive return for the hedge fund investors. There are different types of strategies utilized in the process – some more aggressive, others more conservative. A hedge fund may use derivatives and leverage in order to increase the returns, or avoid high-risk instruments completely for a sure-fire result.
Long/short equity strategy
This is one of the oldest hedge fund strategies. In this strategy, the fund manager buys those stocks which are expected to perform well in the future and shorts the stocks which are expected to be overvalued. Doing so profits the fund manager regardless of the fluctuations in the overall market. This shorting and buying of stocks brings good returns to the investor.
Market neutral strategy
In this strategy, a fund manager buys the stocks that are expected to perform well in the market and shorts the stocks which are expected to underperform. Doing so offsets the profit and loss of both stocks and net market exposure becomes zero. So, the price movement of stocks determines the final outcome of investment rather than market fluctuations. This strategy is less risky but offers lower returns to the fund manager.
Merger arbitrage strategy
In this strategy, the fund manager takes advantage of the price differences in the stocks before and after mergers. This strategy involves buying and selling of stocks through successfully completed mergers. The fund manager buys the shares in the target acquisition before the deal at a discounted rate and sells the shares at a higher price once the deal is done.
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Benefits of hedge funds
Don’t take a hasty decision to call hedge funds a less beneficial investment option simply because it is risky and comprises illiquid capital. There are a wide range of benefits of having a hedge account. These benefits include:
Good financial portfolio
Your financial portfolio will surely improve if you are using hedge funds. These funds are regarded as risky, but they turn out to be quite profitable assets. Hedge funds have aggressive investment strategies. Hedge funds can bring you positive returns in rising as well as falling equity and bond markets. These funds will reduce the overall portfolio risk.
Less vulnerable to volatility
Market fluctuations are one of the major concerns for investors. This problem increases if you are not aware of all the ins and outs of market trends. But hedge funds are never dependent on market fluctuations. Their dependence is on money-making assets, thus making them less vulnerable to volatility. This minimal correlation of hedge funds with the market fluctuations makes them a desirable investment alternative.
Diversification of investment methods
Hedge funds offer investors with a wide range of investment strategies, each one coming with its own set of advantages. Hedge fund managers can choose long/short equity, merger arbitrage, event-driven global macro strategies, and quantitative strategies. Possibilities of generating good returns are endless if you know the hedge funds definition and learn which hedge fund type suits your needs the best. Hopefully, this article was instrumental in familiarizing you with what is hedge fund and the various ways to bring in returns through using them. It’s one of the many ways to invest, and it may just be the right one for you. Do remember the risks of hedge funds and the fact that they are less liquid than mutual funds, requiring investors to keep money in the fund for a number of years.