Hedge Fund Investment

The definition of Hedge Fund

Throughout the history of the stock market, wise investors have looked for ways to minimise risk while maximising profits. The problem of protecting an investment portfolio from uncertainty in the market is often solved with special investments that soften or mitigate losses in value, helping investors to preserve their capital. Investments of this kind are called hedge funds.

A common hedge fund definition is an investment portfolio shared by a group of investors looking for an absolute return on their investment. The phrase "absolute return" refers to the fact that hedge fund strategies are designed so that the fund should always make money, even if there is a decrease in value of some of the investments in the fund, or a drop in the value of the market as a whole.

Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment. Investments in hedge funds are illiquid as they often require investors to keep their money in the fund for at least one year.

For the most part, hedge funds (unlike mutual funds) are unregulated because they cater to sophisticated investors. In the U.S., laws require that the majority of investors in the fund be accredited. That is, they must earn a minimum amount of money annually and have a net worth of more than $1 million, along with a significant amount of investment knowledge. You can think of hedge funds as mutual funds for the super rich. They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more flexibility in its investment strategies.

All hedge funds are supposed to be hedged from risk; hence the name.

Hedging is actually the practice of attempting to reduce risk, but the goal of most hedge funds is to maximise return on investment. The name is mostly historical, as the first hedge funds tried to hedge against the downside risk of a bear market by shorting the market (mutual funds generally can't enter into short positions as one of their primary goals). Nowadays, hedge funds use dozens of different strategies, so it isn't accurate to say that hedge funds just "hedge risk". In fact, because hedge fund managers make speculative investments, these funds can carry more risk than the overall market.