What are Hedge Funds?

March 10, 2014 Debbie Jacobs In the News

Hedge funds are relatively new vehicles for investors which have been on the investing radar for about twenty years. Since they are restricted to only the wealthiest of investors, the average investor knows very little about them.

Hedge funds can be compared to mutual funds, investments that spread risk by investing in a variety of different companies from a range of sectors. The idea is if one sector does poorly, or one or a few particular companies don’t perform well, other sectors or companies will still perform well, evening out the effects of the losses of the investments that aren’t doing well. This pooling of assets is generally a safe way to invest, and it is a popular choice for IRA accounts, 401(k) plans, and other retirement accounts. Mutual funds are highly regulated and investors are protected from serious loss. At the end of 2012 there were 7,596 mutual funds in the US with $13 trillion in assets under management.

Hedge funds are also funds with pooled assets, but instead of the assets coming from traditional types of investment vehicles such as stocks and bonds, hedge funds can invest in anything. This is why they are also called “alternative investments.” Examples of where hedge funds put their money are selling short, trade options, derivatives, borrowing money to enhance returns, and much more. All markets and any opportunity is fair game for hedge funds. Because of the high risk these vehicles possess, regulators limit access to only “qualified investors,” such as wealthy individuals and intuitional investors like pension funds, endowments and foundations.

What about that word “hedge?” We all know the expression to “hedge your bets,” meaning setting limits or qualifying something with conditions or exceptions. It is a way to protect an investment by reducing risk. Today most hedge funds simply do not do this anymore, but the name has stuck despite it no longer being an accurate description, although it was in the past. The main goal of most hedge funds is to minimize volatility and risk while also trying to preserve capital and bring good returns.

Another difference between mutual funds and hedge funds is liquidity. This is a crucial difference for many investors. Mutual funds can be traded every day at the market price. It is publicly traded and easy to sell. Not so hedge funds. Most hedge funds can only be sold or added to at the end of each quarter. And there are some hedge funds that only allow investors to get in or out once a year.

It is good advice to only invest in vehicles that are well understood. Confusion around what hedge funds are and how they work is a good reason to stay away.

Hedge Funds, mutual funds,

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