What is a hedge fund. Features and differences from investment funds
What is a hedge fund
A hedge fund is a type of investment fund whose main purpose is to provide its participants with the maximum possible profit at minimum risk. Hence, the fund's name "hedge", which translates as insurance, protection or guarantee. Hedge fund managers are engaged in the trading of securities (stocks, bonds, etc.).
Often, fund managers of these funds use complex and sometimes exclusive trading strategies. They are based on short positions, leveraged trading and derivatives.
Features of hedge funds
At first glance it may seem that this type of fund is no different from other similar institutions, but it is not. And we will tell you all about it.
First, hedge funds have a very interesting ownership structure. It is often the case that the fund consists of a managing partner, i.e. the founder of the fund, and partners with limited liability, i.e. investors. Only professional or accredited investors, who make a large contribution of $5 million and more, may become a member of the fund. If institutional investors want to join a hedge fund, their entrance threshold will be even higher, starting at $25 million.
Second, hedge funds do not fall under the jurisdiction of the SEC, which means they expose investors to more risk. Based on the fact that hedge funds are not regulated by the SEC they cannot promote their services in the market. Therefore, you will not find their ads on the top channels and programs. The second consequence of the lack of regulation from the SEC is that hedge funds cannot accept money from the public.
Differences between hedge funds and investment funds
The features of hedge funds described above are only part of the differences from conventional investment funds. In addition to these, there is a difference in the size of the fees. In conventional investment funds, the commission is usually 1% of the amount of funds under management. That is why managers of such funds are interested in their increase and promote themselves in financial programs and other areas.
The remuneration of hedge fund managers is distributed differently. First, hedge funds give a higher percentage to the manager, which ranges from 1 to 3 percent. Second, a hedge fund receives compensation from the profits made by the fund's members. The most common number is 20%, sometimes less and sometimes much more.
Hedge fund allocation structure
In order to explain the distribution structure of a hedge fund, we need to simulate the situation. Imagine a certain David who created his hedge fund in which he attracted $100 million of investment from 4 investors. The share of each investor was equal - 20 million, and another 20 million belonged to David, for a total of 100 million.
David takes a commission of 2% of the amount for the management of the hedge fund, and deducts it at the end of the reporting period (month). Let us assume that at the end of the reporting period (month), the hedge fund David showed 20% of profits, and now in "his hands" is the sum of 120 million. From this amount, David takes away 2% of the commission, which is $2,4 million, and thus for the rest of the month the balance of the fund will amount to $117,6 million.
Given the fact that five investors with equal shares broke into the fund, $17.6 million must be divided by five. After this operation, we get $3.52 million for each investor. At the beginning of each reporting period, investors reconsider their shares and continue.
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The history of hedge funds
The practice of creating hedge funds began in the late 1st half of the 20th century, namely in 1949, the famous sociologist and journalist Alfred Jones created his hedge fund. The first fund was called A. W. Jones & Co. whose purpose was to manage the funds of Alfred himself and his friends. Manager's strategy was simple but effective. Jones bought stocks of companies which, in his opinion, would go up in price, and opened deals on selling the shares he thought would go down.
And you know, such a strategy yielded good results. Between 1960 and 1965, the hedge fund A. W. Jones & Co. posted 100% higher profits than its closest competitors. And on a 10-year basis, its profits reached 670%.