With the markets in their current unpredictable state, hedge funds, in particular, have recently been thrown into the limelight, receiving more publicity than they usually do – most likely a little unsettling for this notoriously secretive bunch. Perhaps that’s why, though we recognize the term, few of us actually know what a hedge fund is or does.
To understand what a hedge fund is, let’s first take a look at what it’s not: a typical mutual fund. While these types of funds can generally only buy and sell stocks and bonds, a hedge fund can do a lot more. They typically have far more freedom when it comes to what they can invest in and how they do it, as the majority remain largely unregulated by any official body – for the moment at least. Investing in a hedge fund, therefore, can lead to a whole lot more money because they can use more varied and aggressive strategies.
The primary aim of most hedge funds is to reduce your investment’s risk and volatility – or the amount of uncertainty about a change in the value of whatever you’re investing in – while attempting to preserve or make money no matter what state the market is in.
There are two basic reasons for investing in a hedge fund: to seek higher returns and/or to seek diversification for your investment portfolio. If you have a wide range of investment options, and one doesn’t work out, at least you have a variety of others, so the impact on your financial return – the amount you make or lose – is somewhat minimized.
It’s for this reason that hedge funds are so lucrative – and yet so secretive. Come up with the winning strategy and you make a lot of money. Let someone figure it out and, by copying you, they’ll cause you to lose your unique selling point to investors, as well as your unique grip on the market.
