Investment

The General Features, Pros & Cons of Hedge Funds

hedge funds

Hedge funds have always been the go-to alternative investments for many business investors and have been known to rack in lucrative active returns. But you have to employ many different strategies to realize any actual returns in your investments or alpha. Lest you end up running massive losses in your unplanned investments.

And that is why you need the help and aid of a reputable and renown hedge fund investment firm to guide you through the process. Stonegate Global Fund Services is one such service that can nurture your investments and see them grow. Hedge funds can be aggressively managed and even made use of to get some leverage or derivatives in both the domestic and international markets. That is not to say that it does not have its share of shortcomings. What you get from your hedge fund investments depend a great deal on what you do and how you prepare yourself for the whole investment process. Hedge funds are generally only accessible to the accredited investors since they require less SEC regulations compared to the other funds.

Hedge fund investment always looks to be a lucrative deal thanks to the fact that this particular industry faces less regulation compared to the mutual funds or any other investment vehicles in the market. Hedge funds generally aim to take advantage of any identifiable market opportunities that are credible. Plus, the fact that you can exploit many different strategies to get more out of your hedge fund investments is a bonus. There is also considerable diversity in the risk attributes among styles.

Hedge fund investments also require that you pay up a large initial minimum investment. The fact that they are also illiquid means that the investors in these funds may be required to keep their invested money in the funds for a year or more a time. This period is known as the lock-up period. It is also crucial to note that the withdrawals of your funds are also restricted to certain intervals and durations like quarterly or bi-annually.

Pros & Cons of Hedge Funds

As with everything else, hedge funds also come with its fair share of pros and cons which will affect your overall portfolio. It all depends on how you plan your portfolio. Starting or getting into a hedge fund is a pretty risky investment. But one that can reap ridiculous expenses if the market shifts in your favor. This is what the professional investors call the ‘boom’ period. On the other hand, things can go south with your investment, and you end up running at a great loss. This is what the pro investors call the ‘bust.’

The Pros of Hedge Funds

Aggressive Investment Strategies

One of the plus sides of the hedge fund investments is that you can use aggressive investment strategies to get higher returns. Some of the aggressive investment strategies that you can use in the local and the international market are derivative, leverage, and long and short. Investors, thus, can borrow and trade funds on top of the capital that they have gained. This is the leverage strategy and can extremely boost your returns. But then again, you need to acknowledge the fact that the chance for big gains is also measurable by an equal chance of potentially huge loss. And that is the reason why the investors who choose to use this strategy also need to employ complex risk management tools that should help to reduce the possible associated risk to the investment.

Flexibility

The absence of any obscure financial instruments may be the most significant advantage that the hedge fund industry has over the traditional mutual funds. There are many different strategies that you can employ here as well. One such attribute is the merger arbitrage, and it offers the investors modest returns and at very low risks. Hedge funds can also use leverage to gear up the strategy and help make the returns be more attractive and still have the risks at an acceptable level. You cannot find the same with the mutual funds as the law limits their reach and use of leverage.

Take, for example, the 2008-2009 financial crisis. The hedge fund industry managed to utilize the esoteric financial instruments to their advantage, and the investors were able to make big bucks off of it. The same cannot be said for the mutual funds whose investors were also able to reap significant profits but not as much when compared to the hedge funds.

Huge Gains

If you take advantage of your hedge funds investment portfolio and utilize every leverage possible to gain as many profits as possible, then you can be sure to reap a ridiculous amount of money. Hedge funds always aim to ensure high returns despite the market fluctuations at any given period. Take the “global macro” approach for example. This strategy works to take as much of commodities, bonds, and stocks, etc. as possible. This happens through forecasting the investment opportunities that relate to what may happen in the future global economic events. The main reason why this is done is so that you can get the largest possible return on your investment and the least amount of risk involved.

Good Performance

Hedge funds also have close to unlimited freedom when being invested and this strategy also works a lot in favor of the investors as it can potentially generate very high returns. And if you are lucky enough to have your hedge fund investment catch the upside of a market that is on the rise and also offset the risk of the market falling, then your investment can rack in a lot of money. Everyone is always looking to have a massive return on their investments. And this can be one of the best ways to go about it.

Expert Advice

If you have ever wondered why those people who work in hedge fund investing are usually paid generously, then know that there is a good reason behind that. Aside from there just being big gains that the expert advisors can capitalize on, investors can also enjoy the expert advice and experience that the financial investment officers have to offer. So, the moment you invest in hedge funds, be sure to get extremely experienced and knowledgeable advice from the investment experts. These expert advisors can help you know when you should anticipate market fluctuations and where the domestic market is better than the international and vice versa. These pieces of expert advice can, in turn, help you ensure a higher chance of getting more substantial returns on your investments.

Diversification

Hedge funds are also diverse in investment strategies that you can apply in your investment tactics to maximize your overall returns. Some of the strategies include tactical trading, long/short, event-driven and emerging markets. This reduces the total fund exposure to any one specific style.

The Cons of Hedge Funds

Large Investment Fees

The often-high fees of the hedge funds mark one of the major disadvantages of this investment. The overall fee that hedge fund investors typically charge includes both the management fee and the performance fee. In most instances, you find the management fee is always 2% of the total net value of the fund. This fee is paid every month. The performance fees take 20% of the everything you earn in any given year. The performance fees are used to motivate the managers in most cases so that they can create bigger profits from the investments. These fees are typically a lot higher than most of the other investment vehicles. The mutual funds, for example, always have their management fees being lower than the 2% that is included in the hedge funds. Plus, you also will not have to deal with any performance fees in the other investment vehicles.

Standard Deviation

Hedge funds use a statistical tool called the standard deviation which works to anticipate the risks involved in investing in particular hedge funds. So, the standard deviation tool essentially aims to measure the volatility of the possible gains of your investments. And this measurement is expressed as a percentage each year. This can be an excellent tool for measuring your potential variations in profits in a given year. The downside of this tool, however, is in the fact that it does not indicate the overall bigger picture of your investment’s risk of return.

Risks and Returns

Hedge funds are usually regarded as investments where you take incredibly high risks in the hope of receiving larger returns. And this aspect of hedge funds works as both a strength and a weakness. And the main reason behind this is that the higher the risks, the higher the returns will be. And that may lure you to want to try and risk more in the home of receiving higher returns. But you also need to know that the chances are high that your investment may also run at a loss.

Downside Capture

The downside capture is also another risk management measure that investors use to assess the level of correlation that a hedge fund has on a specific market when that market is on a decline. This can be a very beneficial tool. But it can also be a misleading tool. In that, all funds are usually compared to a unified benchmark. So, if you hedge fund manager chooses to use a different style of investing other than the benchmark, it is likely that the downside capture ratio is going to record that your investment fund is underperforming the benchmark when in reality, it is generating high returns.

Tying up your Money

During the lock-up periods, the investor has no access to his/her money. He/she cannot withdraw the funds during this time until the withdrawal window comes to and is usually at intervals. These intervals may be biannually or quarterly. The downside to this feature is that you never know what the future has in store. With the mutual funds and other investment vehicles, you can buy or sell your portfolio or make a low-cost traded fund on any day of the week. The same is not so with the hedge funds where you may have to wait some four or six months before accessing your money. This can be a significant downside especially if you need the money urgently.

Leverage

When leverage rises, you realize that any downsides in the investment returns are magnified. And, in most cases, this often forces the hedge fund to sell its assets at a lower price. Simply put, leverage is the primary reason why most hedge funds always go bankrupt.

Strategies to use in the hedge funds

By now you should already know that the hedge fund investment process comes with many different strategies that you can apply to improve your chances of receiving higher returns. Some of those strategies have been discussed below. You can employ some of these strategies to try and minimize the range of risk tolerance in your portfolio.

Credit Funds

These funds usually tend to follow the cyclical patterns and are always most active following the economic restrictions and downturns in the credit market. These funds also make debt investments based on the investor’s lending inefficiencies. Credit funds can include distressed debt strategies which involve investing in bank and corporate bonds.

Arbitrage Strategy

These strategies seek to play a vital, visible role on the price difference between the closely-related investments. It does this by simultaneously purchasing and selling the available investments. When properly utilized, these strategies can reflect consistent remarkable returns with low risk. These strategies, however, rely more on leverage to receive any significant returns on investments.

Event-Driven

The event-driven strategies, on the other hand, require that you have sufficient knowledge in fundamental analysis and modeling of the corporate events. This particular strategy also closely pertains to the arbitrage strategy as it seeks to exploit the pricing inflation and deflation rates that occur due to specific corporate events. Examples of event-driven strategies include risk arbitrage, merger arbitrage, event-based capital structure arbitrage, and distressed debt.

Quantitative Strategies

These strategies rely on the quantitative analysis to make any investment decisions. The quantitative strategies work to utilize technology-based algorithmic modeling to ensure you achieve your desired investment objectives. And that is the reason why they are sometimes referred to as the ‘black box’ funds. The reason behind this is that these strategies have limited access to the investment strategy specifics.

Multi Strategy

These strategy funds are not open to any single investment objective or strategy. However, it uses many different investment strategies to achieve a positive return regardless of the overall market performance. These strategy options tend to project the lowest chances of risk tolerance and manage to maintain a higher priority on capital preservation.

About Ajeet Sharma

My Name is Ajeet Sharma Financial Blogger & Founder of Financegab.com. We are a personal finance blog dedicated to personal finance & financial planners. The main aim of this blog is to help people to informed financial decisions.
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