What is a hedge fund?
A hedge fund is a type of investment vehicle that allows investors to pool their money together and invest in various assets. These funds are usually used by high-net-worth individuals and institutional investors and can be quite complex.
The way hedge funds work is that the fund manager will use the investor’s money to buy various assets, including stocks, bonds, currencies, and commodities. The idea is that by investing in several different assets, the hedge fund will minimize its risk if one or more of those investments falls in value, thus the name “hedge fund.”
Hedge funds are not available to everyone and usually require minimum investments. These kinds of investments are explicitly reserved for “accredited investors.” To qualify as an accredited investor, you must have a net worth of at least $1M or be earning an annual income over $200K in each of the two most recent years as an individual or an annual joint income over $300K in those years with your spouse. Only accredited investors are allowed to take part in hedge funds due to the higher level of risk associated with these investments. The thought process behind this by the SEC is that if an investor has a particular net worth or income, then they have the knowledge needed to make an informed decision on their investments and they understand the risks and rewards of hedge funds.
It is also important to note that there are multiple investment strategies that hedge funds can use. These strategies include long/short equity, global macro, and event-driven investing.
Hedge fund case study
If you’re an investor looking to invest in multiple projects and maximize your gains, a hedge fund may be right for you. Let’s take the example of an investor interested in investing in a hedge fund.
One of the primary reasons that someone may invest in a hedge fund is to gain access to funding managers who are experts in investing. If you are looking for more aggressive strategies, rather than spending years trying to develop an investment strategy of your own, investing in a hedge fund can allow you access to those strategies right away.
Say you invest in a hedge fund, “XYZ,” known for having investments in the technology, biotechnology, and real estate sectors. This hedge fund has done well over the past few years as they have consistently made money from their investments in these specific industries.
If you were to invest in multiple industries by yourself, you might have extensive knowledge in one industry but minimal knowledge in another. This can put you at risk if that industry happens to have a bad year and your investment falls in value.
However, by investing in XYZ hedge fund, you are getting access to the expertise of their entire team, who all specialize in different areas.
This is just one example of why an investor may want to invest in a hedge fund. Many other reasons include hedging against market downturns, gaining access to unique assets, and tax breaks than mutual funds.
The bottom line
Hedge funds allow you, as an investor, to diversify your portfolio and use professional portfolio managers’ skills to help you minimize risk. However, these funds come with high barriers to entry and are not available to everyone. You must be an accredited investor to participate in a hedge fund.
Hedge funds can be an excellent investment for investors who want exposure to a particular sector or are interested in multiple investments within that sector.