Definition of Hedge Funds:
Hedge funds are investment funds that gather funds from multiple investors and utilize them to invest in securities, they are a lot similar to mutual funds. Compared to mutual funds, hedge funds have a more limited range of investors who are eligible to invest in them, this means that generally, hedge funds are not available to the public. hedge funds are usually limited to individuals with high net worth and institutions. As an example, the minimum investment required by mutual funds might be a few hundred dollars while the minimum required to invest in hedge funds hovers around $100.000 and can even go beyond $1 million for some of them. Hedge funds have significantly grown in recent years and their assets under management approached $3 trillion in 2015, As of the 4th Quarter of 2022, total assets under management were almost $5 trillion (precisely $4843.6 billion).
Hedge Funds fees:
Hedge funds generally charge much higher fees than mutual funds, and usually, hedge funds fees follow the “two and twenty rule”, this rule means that investors have to pay an annual fee equal to 2% of the assets managed by the hedge fund plus 20% of any gains achieved by the fund, one of the fees that hedge funds charge is the management fee and does not depend on the performance of the fund the second fee that these funds charge is the incentive fee which is only paid by the investor if the fund earns a positive return. The incentive fee in hedge funds commonly includes a “high-water mark” feature, which means that the fee is not payable until the fund surpasses its previous highest value (peak value).
Hedge Funds regulations:
Unlike mutual funds, hedge funds are not as closely monitored by regulatory bodies such as the SEC (security and exchange commission) in the United States, this means that hedge funds have more flexibility in their investment strategies and usually expose investors to significantly greater risks since they are not subject to the same level of regulations as mutual funds. However, this does not mean that hedge funds are entirely unregulated, the regulation of hedge funds varies from one country to another, for example, in the United States hedge funds are subject to registration and reporting requirements imposed by the Investment Advisers Act of 1940, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 on hedge funds with over $150 million in assets under management. Despite the regulatory challenges, investors in hedge funds can still protect themselves by conducting due diligence and carefully considering the risks and rewards before making any decisions.
Hedge Funds VS. Mutual Funds:
Hedge Funds
- Only accessible to investors with large capital.
- High risk.
- Less liquid.
- High management fees.
- Low transparency.
- Less regulated.
Mutual Funds
- Accessible to the general public.
- Low risk.
- More liquid.
- Low management fees.
- High transparency.
- More regulated.
Common strategies utilized by Hedge Funds:
Hedge funds employ a diverse array of strategies to navigate financial markets. We’ll delve into common tactics such as long/short equity, global macro, event-driven, multi-strategy, and quantitative strategies, shedding light on how hedge funds aim to seize opportunities and manage risks.
Long/Short equity strategy:
The Long/Short equity strategy revolves around taking long positions on stocks expected to appreciate in value, while concurrently assuming short positions on stocks anticipated to decline. Hedge fund managers typically acquire shares in companies they believe will prosper while simultaneously selling short shares in rival companies they expect to face challenges. What sets this strategy apart is its capacity to generate profits from both long and short positions.
The Global Macro strategy:
The Global Macro strategy centers on investment across diverse asset classes, including stocks, bonds, currencies, and commodities. This approach empowers hedge fund managers to diversify their portfolios, capitalizing on macroeconomic trends and geopolitical events. For instance, hedge funds may turn to gold as a hedge against inflation, given its historical resilience to rising prices, or they might explore investments in emerging markets, driven by the belief in robust economic growth within these regions.
Event-driven strategy:
The event-driven strategy empowers hedge funds to capitalize on market events such as mergers and acquisitions, company bankruptcies, and corporate restructuring. For instance, a hedge fund may choose to acquire shares in a company on the verge of being acquired. This strategy aims to profit from the price differential between the company’s current valuation and its anticipated valuation post-acquisition. The spread between pre-acquisition and post-acquisition prices forms the foundation of the fund’s profit.
Quantitative strategy:
The quantitative strategy relies on mathematical models to analyze vast amounts of data with the aim of identifying investment opportunities. Hedge funds employ data analysis to assess which stocks are likely to outperform their peers based on a multitude of criteria. To further enhance efficiency, hedge funds employing this strategy often utilize algorithms to execute trades.
Multi-strategy:
The multi-strategy approach entails the integration of various investment strategies to achieve risk diversification and returns from multiple sources. For instance, a hedge fund may blend a long/short equity strategy with event-driven and quantitative strategies to create a balanced portfolio and mitigate overall risk. Typically, this strategy is favored by large hedge funds that can harness a substantial team of analysts and traders to execute multiple strategies at the same time.
In understanding these common hedge fund strategies, investors can gain insights into the dynamic and multifaceted nature of hedge fund investments, where the pursuit of returns and risk management go hand in hand.
5 of the World's best-performing Hedge Funds:
| BRIDGEWATER ASSOCIATES | David McCormick | $150 billion | not publicly disclosed |
| AQR CAPITAL MANAGEMENT | Cliff Asness, David Kabiller and John Liew | $143 billion | 9.67% as of December 31, 2021 |
| DE SHAW & CO | David E. Shaw | $60 billion | 11.5% between 1996 and 2020 |
| TWO SIGMA | David Siegel and John Overdeck | $58 billion | 10.10% from 2015 to December 2021 |
| WINTON GROUP | David Harding | $10 billion | 11.3% from 1997 to 2019 |
please note that the information provided right above may not be up-to-date or current.
