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About Hedge Fund
As an investor, you may have a lot of options in the market to get profitable returns, some riskier than others.
Based on some unique strategies and planning you can ensure some profitable returns through multiple options of investments.
One such distinct type of investment is hedge funds. In this post, we will understand what is a hedge fund and how hedge funds work in detail.
What Is Hedge Fund?
Hedge funds collect money from investors and invest in securities or other types of investments to earn profitable returns.
These types of investments are not as heavily regulated as mutual funds and generally have more freedom than mutual funds to make investments and strategies that elevate the possibility of investment loss.
Hedge funds are limited to wealthy investors who can afford the higher fees and risks of investing in hedge funds and institutional investors that also include pension funds.
Investing in hedge funds is only open to a limited group of investors and their performance is measured in absolute units of return.
If you look up the meaning of the term Hedge (Hedging), it means reducing the overall risk. This is usually done by taking an asset position that helps offset the existing risk.
How Do Hedge Funds Work?
These investment options were originally established to hold long and short equity positions, meaning they are “hedged” to reduce risk.
Investors can make money regardless of whether the market is up or down. Later, the term was expanded to include all types of pooled capital dispositions.
In operation, a hedge fund manager collects money from outside investors and invests the funds according to whatever strategy they promise to use.
This type of investment has an operating agreement that explains how it will be directed.
This management will contain a fee structure, which is usually a management fee of 1% to 2% of assets, plus 20% as performance fees, meaning the manager that is managing your funds will earn 20% of any annual profit they generate for you and the rest is your profit.
A performance fee incentivizes these fund managers to take on more risk to earn higher rewards.
The more money a fund makes, the more money investors and fund managers earn in profits. Most of the fund managers accept the standard “2% and 20%”. However, some fund managers are paid purely on profit sharing basis.
How Are Hedge Funds Categorized?
This type of fund is designed to take benefit a particular market movement. They can be divided into different investment strategies such as event-driven investing and fixed income arbitrage.
These investment categories are based on the investment style of the manager managing your investment.
Legally speaking, these funds are usually set up as private investment limited partnerships with access only to a limited number of authorized investors and require a huge initial minimum investment.
These types of investments are illiquid because they often require investors to hold their money in the fund for at least 12 months, a period known as a lock-in period.
Withdrawals may also occur at certain intervals, such as once in a quarter or twice a year.
What Are The Minimum Hedge Fund Requirements?
Remember that hedge funds are not for everyone. You must meet the definition of an accredited investor to invest in hedge funds. You are considered an accredited investor if you meet the following requirements:
- The potential investor’s net worth should be over $1 million, owned alone or jointly with a spouse.
- The potential investor must have earned $200,000 in each of the last two years.
- The potential investor must have $300,000 in each of the last two years combined with a partner.
- The potential investor should have a reasonable expectation of earning the same amount in the future as he did in the last two years.
Conclusion
Investing in a Hedge fund could be a great way to have a streamlined profit. However, you might want to consider the overall risks and costs before making this type of investment.
Make sure that you are qualified according to the requirements and know about the lock-in and withdrawal periods before investing in these pools of funds.
