Understanding hedge funds

A hedge fund is an investment structure that is pooled and is set up by investment advisors or money managers. The pool takes the form of a limited liability company or limited partnership the money manager raises funds from different investors and put it into an investment according to a strategy that he/she has put in place. Some hedge funds deal with long-term equities meaning they never short sell, the only buy common stock.  others engage in private equity where the manager buys an entire business and works on improving the operations, after which they will sponsor an IPO or initial public offering. Other hedge funds trade in junk bonds.

 Some hedge funds specialize in the real estate industry while others put the money in asset classes that specialize in certain areas like music right and patents. It is therefore very clear to see that hedge funds can specialize in almost anything.

Initially, hedge funds held stocks whether for long-term or short-term positions and the investors were sure that they could make money regardless of how the market fluctuations were.

Fund managers make money by getting compensation as per the terms found in the agreement of operation. Some get 2 percent of assets calculated on the net amount annually plus 20% on profits that are above a predetermined rate. Others make money purely on profit buffet arrangements. Most managers operate with a clear understanding of the ‘high water mark’ that simply means that if the fund does not do well, he/she will have to make up the losses before receiving their payment.

Almost anyone can invest in a hedge fund. However, some government regulations only allow investors with accreditation to do so. This means that if you do not qualify, the manager will not give you membership or partnership into the firm. He only has a provision for 35 non-credited investors and so it is very tough to get in if you do not qualify. To be an accredited investor you have to meet one of the following criteria:-

  • have a personal income of over $200,000  or a combined spousal income of $300,000 per annum. You must show that you have earned the income for at least two consecutive years and you must be sure that you’ll be able to retain the level of income in the near future.
  • Have a personal net worth of 1 million dollars or more, whether by yourself or together with your spouse. This should exclude your primary residence.
  • Be or director or executive partner tied to the hedge fund.
  • Be an employee on a financial plan or trust fund with  $5,000,000 or more and not necessarily with the purpose of investing.
  • Be part of a company where all the investors have on their own merit qualified for accreditation.

Accredited investors have the knowledge and experience to understand the risks and merits of their investment.

Having a proper understanding of hedge funds is important if you are going to use it as a way of investing. The fact that you pool resources means that more people may lose if it doesn’t work out.  this is why it is important to work with a money manager who understands the process and can advise you on the best investment to undertake.