Hedge Funds

Hedge funds originally started as an equity investment vehicle in which offsetting short and long positions protected the overall portfolio against major stock market moves. Today, the name hedge funds is a misnomer. They are not restricted to equities or just hedging strategies. Hedge funds are private pooled investment vehicles that can invest in a wide variety of products, including equities, fixed income, derivatives, foreign exchange, private capital, and real assets. It is the investment approach rather than the underlying investments that distinguish hedge funds. Many hedge funds operate in all kinds of financial markets by using leverage, short selling, or using f inancial instruments that are not often used by other similar commingled funds, such as mutual funds. This may result in a very different risk and return profile than owning underlying assets themselves.

The hedge fund industry is in a state of constant change as several hundred new funds are launched each year, with a similar number of funds exiting or being liquidated. While several jurisdictions around the world regulate hedge funds, often they are lightly regulated compared with other investment vehicles.
 

• Hedge funds are private investment vehicles with pooled funds from institutions and high-net-worth (HNW) investors. Hedge funds typically have more flexible investment strategies than other options, such as mutual funds and ETFs.
• Hedge funds are not an asset class but are a variety of investment vehicles driven by a set of disparate investment strategies. Most hedge funds utilize some form of leverage to enhance potential returns.
• Hedge funds are typically classified by strategy. A variety of classif ications are possible, which helps in the selection of appropriate investment strategies and appropriate performance benchmarks and in reviewing aggregate performance.
• Most hedge funds are set up as limited partnerships, with the portfolio manager acting as a general partner (GP) and the institutional investors acting as limited partners (LPs). This is the direct form of hedge fund setup. For smaller and retail investors, indirect forms, such as funds of funds, help obtain a hedge fund exposure.
• The legal and contractual relationship between the GPs and LPs is governed by the fund offering documents. In addition, a manager could draft a “side letter” applicable to some investors only, with different legal, regulatory, tax, operational, or reporting requirements.
• Hedge funds use several strategies, such as market-neutral, relative value, and event-driven strategies, to obtain diversification benefits and to attempt to outperform equity markets on a risk-adjusted basis.
• Hedge fund strategies are classified by a combination of the instruments in which they are invested, the trading philosophy followed, and the types of risks assumed.