Hedge fund is the type of investment with relatively low regulating policy. This investment has much more flexible strategies. Most of hedge funds act in the way of borrowing money to increase the risk of investments. They also seek to find short-selling practices that mutual (traditional) funds would rarely use. Most of these practices are usually considered as speculative ones (SEC, 2013).
John Cassidy investigated the issue of “funds of funds” and how they work in his article “Hedge Clipping” (2007). First, the number of hedge funds significantly increased over the last 15 years. The biggest of them: Citadel Investment Group of Kenneth Griffin, Renaissance Technologies James Simons and Edward Lampert’s ESL Investments earned over one billion dollars each last year. Theirs funds use the well-known charges “two and twenty” when the customer pays a fee in amount of 2% out of the amount he invest and 20% out of profit amount he receives afterwards. Such a mathematics allow even small hedge funds to earn a lot until the customers decide to withdraw their investments (Cassidy, 2007). Hedge funds can provide returns much greater than the standard financial market indices (like S&P 500); however, it is also much more risky activity. Well known financial rule states the following: risk and return goes together. After the high-risk activity, a person might get a high return and after a low-risk activity, a person usually gets a low return. Indeed, risk is closely connected with the losses and an investor might get high/low losses when acting respectfully (Cassidy, 2007). In this respect, putting the money in a Royal Bank of Canada C.D. is a very low-risk activity, while investing in hedge fund is rather high-risk activity.
In order for the hedge funds operate successfully, they must not deviate from the specific technical strategies. Financial analysts have been developing these strategies since the time the first hedge fund appeared. One of the most famous strategy – a relative value strategy. According to this strategy, it is necessary to combine long and short positions on a particular type of financial instrument at the same time (Lack, 2012). There is one more well know strategy – event-less strategy. They are based on the expectation of a variety of events. These events can occur in both the economic and political sphere and have a significant impact on current rates of certain instruments.
There is a difference between hedge funds and similar investment structures: the freedom of choice of tactics and strategy. For example, if many financial institutions are legally restricted to earn in a declining market, the hedge funds can fully benefit of this situation to get the maximum profit. In addition, hedge funds have the opportunity to work without any limitations with all the financial instruments. In a rapidly changing market conditions the hedge funds are able to respond much more quickly and flexibly to the changing circumstances.
References
Cassidy, J. (2007). Hedge Clipping. The New Yorker. Retrieved from http://www.newyorker.com/magazine/2007/07/02/hedge-clipping
Lack, S. (2012). The hedge fund mirage. Hoboken, N.J.: Wiley.
SEC,. (2013). Hedge Funds. U.S. Securities And Exchange Commission, 139(2).
