At some point in your investment journey, you must have thought of investing in Mutual Funds. Mutual Funds have come a long way and are widely preferred by investors these days. But there is another type of fund which is gradually prevailing in the market, known as Hedge Fund.
Hedge Funds are considerably new investment product and therefore they are not as popular as mutual funds. However, they work similar to mutual funds by pooling investments from investors. As the name suggests, the primary aim of hedge funds is to delivery high returns by hedging down the risks. Hedge funds are gaining popularity in India at a vary rapid pace.
Let us take a detailed look at Hedge Funds and find out the features and benefits of them. Also, we will try to figure out whether you should invest in Hedge Funds or not.
Table of Content
Hedge Funds Meaning, Features, Benefits & Comparison
What are Hedge Funds?
Before learning about hedge funds, we should first understand the meaning of Hedging. In the investment world, hedging means safeguarding against risks. Hedge funds pool investments from accredited investors including High Net Worth Individuals, Banks, Endowments, Insurances etc. These funds usually don’t require a SEBI registration and neither have to disclose periodic information about NAV like mutual funds.
The portfolio of a hedge fund can comprise of various different asset classes including equities, derivatives, currencies and bonds. Therefore, they are even considered as alternative investments. Since the primary objective of hedge funds is to protect the investor against risks, they need to be aggressively managed. Hedge fund may have short and long positions and employ substantial leverages.
Features and Benefits of Hedge Funds
Hedge funds were introduced in the India market in 2012, after the approval of SEBI for allowing Alternate Investment Funds. Some of the main features and benefits of hedge funds are as follows:
- Qualified and Accredited Investors
Hedge funds have a minimum investment requirement of Rs 1 Crore, which makes them accessible only to accredited and qualified investors. These investors comprise of High Net Worth Individuals, Banks, Endowments, Insurances etc.
- Diversification
Hedge funds are usually diversified because they include a portfolio of assets ranging from stocks, derivatives, currencies, real estates and bonds. Hedge funds necessarily include all the asset classes which are only limited by the mandate.
- High Fees
Hedge Funds work on the concept of both management fee and expense ratio, which means that there is a fixed fee for every hedge fund and also profit sharing. The fixed fee can be somewhere around 2 per cent whereas the profit sharing usually varies from 10 per cent to 15 per cent.
- High Risk
Hedge funds are often characterized by long lock in periods. Since these funds make use of leverages, they are prone to significant losses.
- Regulations
Hedge funds do not require to be registered with SEBI or any other securities market regulatory body, nor do they need to disclose NAV information periodically.
How Do Hedge Funds work?
Performance of Hedge Funds depends more on the skills of the fund manager rather than market movements. Hedge funds are managed by skilled and experienced fund managers who try to generate good returns by reducing the market exposure and risk. Diversification is used across most of the hedge funds for risk management. Some of the main strategies and techniques used by Hedge Fund Managers include:
- Short Selling
Hedge funds often make use of short selling techniques to benefit from a falling market. The fund managers sell securities for buying them back later at lesser price.
- Arbitraging
Securities listed in the stock market may have inefficient or contradictory pricing. Fund managers use this as an opportunity to maximize the returns.
- Investing in upcoming events
Hedge fund managers keep an eye on the major market events like mergers, acquisitions and spin offs and plan their investments accordingly because these events have a great impact on market movements.
- Investing in discounted securities
The prices of the stocks of a company can fall below their actual value due to various factors like financial stress and operational issues. Fund managers often invest in such stocks at unbelievably low prices.
Should You invest in Hedge Funds?
Since Hedge funds are managed privately by experts, they are costly compared to mutual funds. Hedge Funds are thus not feasible and affordable for everyone. However, having sufficient funds in surplus is not the only requirement for investing in Hedge Funds. You must have a very high-risk tolerance, because the fund managers trade in assets at blazing fast speeds to cope up with the market movements. This is also the reason behind the high expense ratio of these funds. The fund managers charge hefty sum for managing the fund.
If you are newbie into the investment world, it is recommended to stay away from these funds. However, as we discussed, the performance of hedge funds depends mostly on fund managers. So, if you doubt the skills of you fund manager, you should be prepared for some sleepless nights!
Conclusion
Hedge funds are considerably new in the market and are gaining popularity rapidly. However, these funds do not require registration with a regulatory body and are often recommended for accredited investors. These funds are managed by an asset manager or fund manager whose primary aim is to generate more and more profits, while safeguarding the investments against the risks in the market. Since these funds make use of leverages, they are prone to high risks. Therefore, before planning to invest in Hedge Funds, it is recommended to have your risk profile analyzed from a certified investment advisor. After your risk profile, if you fall into the band of high-risk tolerance capacity, then only you should proceed for investing in Hedge Funds.
