What Is a Hedge Fund? This Is What You Need to Know

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Business

You’ve probably heard of a hedge fund, but it’s unlikely that you know what it is. And that’s ok because most people don’t. 

In premise, a hedge fund is a structure that is designed to hold both short and long stocks. But now, a hedge fund usually refers to a variety of pooled capital partnerships.

In this article, we will cover what is a hedge fund, as well as some other important information about it

So if you’d like to go from a state of unknowing to a state of clarity, keep reading.

What Is A Hedge Fund?

As mentioned earlier, a hedge fund was designed to hold stocks. These positions were referred to as being hedged, thus risk-reduced. Investors made money regardless of the market is decreased or increased. 

The name remains and now it covers a variety of pooled capital partnerships.

The funds are limited to wealthy investors because they come with substantial hedging fees that are paid to managers. But they still involve more risk than any other type of investment. So that’s what is a hedge fund, let’s learn about the first one ever to exist.

Hedge Fund One

The world’s first hedge fund was created in 1949 by Alfred Winslow Jones. Jones was motivated to try managing money while writing about investments in 1948. 

He had raised a substantial amount of time, including much from his own pocket. He had tried to decrease the risk of holding long-term stock by short-selling others. 

The innovation was referred to as the long-sort equities model. Jones also made use of leverage to improve returns. 

In 1952, he had changed the investment structure so much, that he turned the hedge fund into a limited partnership with a 20% incentive feed for management.

As the first known money manager to use the leverage of shared risk, combining short selling and compensation, Jones earned a much-deserved place in the history of the investment world.

How Does It Work?

A hedge fund manager collects money from outside sources and then invests these monies with whatever strategy they proposed. Some hedge funds:

  1. Use private equity, buying privately-held businesses, improving operations, and sponsoring IPOS
  2. Concentrate on long-only equity, never sell short
  3. Trade junk bonds
  4. Focus on real estate
  5. Place money in specialized asset classes, such as music rights or patents

Hedge funds specialize in a variety of things. There are even hedge funds that consist of many other hedge funds. Learn more about hedge fund investing here.

Hedge funds are not restricted in a particular mode of operation, however, they do have to follow the regulations of law, which are particularly advantageous to hedge funds. However, they often lack insecurities, in comparison to traditional investing models. The lack of insurances and legal protections makes hedge fund investing a risky thing to partake in.

Only the wisest and most capable will benefit from a hedge fund. Many have been known to fall under the pretense of easy money. So now you know what does a hedge fund do, let’s move on.

Partnerships in Hedge Funds

The purpose of a hedge fund is to maximize the returns of an investor, as well as eliminate risk. If this objective sounds like a mutual fund, that’s because that’s the only similarity they share.

Hedge funds are considered to be more risky, aggressive, and exclusive. In a hedge fund, limited partners contribute their monies while the general partner manages the finances.

The very name derives from the hedging trading technique. In keeping to make money, regardless of whether the stock declines or climbs higher, managers can hedge themselves. Even though these strategies reduce risk, in reality, these practices actually increase the risk.

Hedge fund investors became popular in the 90s when high-profile managers deserted into other industries for fortune and fame. Since then, the industry steadily grows with total assets under management in the trillions of dollars. 

Requirements for Hedge Funds

To invest in a hedge fund, one must meet certain net worth and income requirements. Only accredited investors can invest in hedge funds, and this is mandated by law. 

Accredited investors can be an entity or person. Hedge funds are not subject to some federal laws that protect regular investors, this explains the increased risk.

Individuals must:

  1. Have a personal income of over $200000 each year, the income should be maintained for at least 2 consecutive years
  2. They must have a net worth of at least $1000000, excluding their residence

Entities must:

  1. Have all the equity investors are accredited on their own
  2. It can have a collective net worth of over $5000000, not specifically formed for making investments, lead by a sophisticated investor

The Securities and Exchange Commission references the “sophisticated” person as somebody who has enough investing knowledge and direct experience to make educated decisions about the potential investments.

Managers of these funds are compensated in residence with the terms of the operating agreements. Many hedge fund managers receive a standardized percentage. They usually receive 2% of all assets each year, as well as 20% of the profits starting from a limit. 

Other managers are only paid on profit.

Hedge Funds Elaborated

Now that you know what is a hedge fund, you can finally continue your research about the topic and potentially invest in one if you meet the requirements. Hedge funds are a lucrative opportunity, not only to make money but to meet specialized and capable individuals. 

A hedge fund is first a community and an investing structure second. In many cases, the best of comrades and friendships can be built within a hedge fund. 

If you’d like to learn more about investing or similar financial topics, feel free to read the articles on the sidebar.

 

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