May 29, 2008, 6:00 am

What Is A Hedge Fund Part 1

by: The Financial Blogger    Category: Investment, Market and Risk
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Hello readers, I hope you are doing well. Wondering who I am? Well, you’ve actually read a bit about me if you are a reader of TFB. My best friend is your host, Mike. He has been my best friend for over 5 years now, and I now consider myself part of his family (especially since being asked to be his son’s William godfather). Over the years, we’ve been great friends and recently we started discussing a project called M35, that you have read a little about and will about a whole lot more in coming months as we go from a small private company to hopefully something much bigger in the future. As the co-admin of the blog, I have been a lot more invisible to you guys, working more on programming, and on our other projects. But with Mike on vacations, he asked me to do a guest post, which I will do right now. I might be starting my own blog in a few months so we’ll see.

Compared to Mike (who has an excellent perespective of personal finances, tax impacts, strategies to increase returns with leverage), I am very specialised. I work in the investment field, studied it (both in school and finishing my 3 CFA exams), and so my articles will be a lot more related to the investment field. I work in the hedge fund (for your info, a hedge fund is a fund that compared to traditional funds such as mutual funds, is allowed and usually will use relative strategies..more on that later) industry and am able to see a lot of the different strategies that are used right now to generate alpha. Alpha is return that is generated above of what is expected given a given amount of risk.

So I will discuss a few strategies used, but before beginning, here is the definition from investopedia of “hedge fund”:

“An aggressively managed portfolio of investments that uses advanced investment strategies such as leverage, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark).”

Basically, the main difference is that these funds are mostly unregulated. They are thus only available to qualified investors (usually the criteria is to have at least 1M in liquid assets although over the years, it seems to be easier to get in the funds through indirect methods). Another main caracteristic is that the managers of such funds generally have a lot of liberty. They can often trade any type of product (listed or not) on any exchange in the world or in any asset class (credit, interest, commodity, equity, fx).

These funds are generally recognized by their fee structure as well, the tradition 1-20. What? 1-20??? Yes! 1% is the fee that will not vary no matter how poorly or great your manager performs, it is 1% of invested assets (which is not that much compared to other investment vehicules such as mutual funds or even ETF’s). The real difference and incentive for the manager lies in the incentive fee, the 20%. Basically when you invest in these funds, you are charged 20% of the performance of the fund. Sounds a lot? It is. But some of the best hedge funds in the industry are still closed to new investments so it probably is because investors don’t mind giving up 20% of an excellent performance (as well, many hedge fund consider asset growth to be a problem above a certain point as they need to find a lot more market opportunities to generate the same return).


Tomorrow, I will write about 3 different types of Hedge Funds. See ya!



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