A hedge fund is a managed pooled fund for alternative investment method which employs trading into complex products including equities, derivatives, real estate, currencies and many others. The performance of the fund is measured in absolute return units.
As the name suggests, hedge fund tries to “hedge” the risk associated with a particular investment choice based on the price relevant information. Hedge fund managers choose from the variety of options from stocks to bonds and commodities to currencies. Sometimes they may invest their own money to a fund to leverage the magnifying effect of the investment.
Alfred Winslow Jones is regarded as a pioneer in the field of hedge fund management, and he launched the first hedge fund in 1949. Alfred structured the funds by finding the loopholes in the regulations and reaping benefits from them. Alfred formed an investment partnership and committed his own money in the partnership. He fixed his remuneration in the form of performance incentive, which was 20% of profits.
Alfred, in his endeavour, combined shorting and leverage, and hedged them against the market movements and reduced the risk exposure. He chose equal short and long positions for his portfolio. The overall impact of the combination of long and short positions, his portfolio became more stable with lower risks.
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Many fund managers joined Alfred to gain fame and fortune. Some of them even went to start their own fund houses and an SEC report of 1968 reported 140 hedge funds in the United States of America.
During the stock market boom of the late 1960s led to a belief that Hedge Funds underperformed than the overall market. Many hedge fund managers dropped the idea of long term and short term positions and did not feel the need for risk hedging.
To take the benefits of the market boom, many fund managers moved out from the Alfred technique of lowering market movement risks. The fund managers moved boldly to the riskier strategies, which led to heavy losses in 1969-70. The bear market of 1973-74 drove a massive plunge in hedge funds and saw closure of many such funds due to heavy losses.
During the mid-80s, hedge funds again became centre of attraction for large investors due to the Julian Robertson’s Tiger Fund. The fund was one of the many global macro funds that used leveraged investments in securities and currencies after careful assessments of global macroeconomic and political situations.
Tiger Fund, in 1985, correctly forecasted the end of the four-year trend of the US dollar appreciation against currencies of Europe and Japan and speculated in non-US currency call options. A report in the year 1986, reveals that since its inception, Tiger Fund gave an average of 43% return to its investors.
During the late 1990s, hedge fund suffered one of the largest losses. Quantum Fund lost US$2 billion in 1998 during the Russian debt crisis. Tiger Fund lost more than US$2 billion in trading of Japanese Yen with respect to the US dollar. The losses and redemption of money by the investors led to the closure of the Tiger Fund in 2000.
The hedge fund industry has evolved substantially, and their numbers are in thousands and managing trillion dollars of investment around the globe. Their Modulus Operandi has also evolved over the year. They ask their investors to put the money in locking period of a minimum of 1 year.
Hedge funds are usually open to qualified investors. The fees charged by the fund managers are also generally on the higher side, around 2% of the underline asset value plus the performance fee on gains generated.
The basic principle of hedging the investment has now changed, and the key focus is to maximise profits or to give higher returns on the investments. To achieve higher returns, fund managers often put their money on higher risk elements.
Fund managers use leverage to increase the spread of profit, but at the same time, leveraging can incur more loss than the actual investment would have made. Speculative investment has the potential of higher risk and huge losses.
Being said that, the past financial blunders of hedge fund have also provided expensive learning and experience to the fund managers. Building upon the legacy, hedge funds have given higher returns over the years.
The average rate of returns of hedge funds attracts most of the wealthy investors towards them. They invest in anything from bonds to securities to currencies and even real estate. There is no fixed rule of investment or instrument for investment, and no definition could cover the entire system of hedge funds.
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