Hedge funds are a great way to diversify your portfolio if you have the money, but you shouldn’t dive blindly into the market. There are some things you should know before you get involved in this type of market so you can make the most profit.
Hedge Fund Managers are Compensated
A portion of the profits goes to the manager of the hedge fund, because they oversee the decisions and investments. The percentage paid to hedge funds managers is called “two and twenty” because they are paid 2% of the total asset value as a management fee and an additional 20% of any profits earned from the hedge fund. Not every hedge fund manager practices this action, and some have set a standard fee of 1.5% of assets and 17.7%. However, the top performing hedge funds still charge 20%.
Hedge Funds Can be Risky
Ask any investor and they’ll tell you that hedge funds are quite risky. No regulatory agency, including the Securities and Exchange Commission, has control over hedge funds—which can make investing millions a dangerous bet. Regardless, many people continue to invest in hedge funds because of their flexible investment strategies amd infamous chances of very high returns. Many managers use leverage, short-selling, and other speculative investment practices to increase profit for investors.
Hedge Funds are Limited to a Certain Economic Status
Managers seek out accredited individuals that have at least $1 million in net assets not including their primary residence. The middle class has a chance to participate in hedge funds if they are included in an exchange-traded fund (ETF). Qualified purchasers may also invest in hedge funds, but they need to have a minimum of $5 million in investments—not including their primary residence or any property used for business.
Hedge Fund Managers Use a Variety of Strategies
Hedge fund managers invest in a number of strategies to get profit for investors. Some of these strategies include equity hedge, long/short, market neutral, global macro, and relative value arbitrage. These are specialized ways of saying what the manager invests in. For example, an equity hedge is a fund that takes long positions in stocks that are expected to appreciate and short positions in stocks that are projected to decline. Global macro is a high risk/return profile that invests in stocks, bonds, currencies, commodities, options, futures, and other forms of derivative securities.
Hedge Funds Use Borrowed Money
Hedge funds borrow money from investors, called leverage, to put more money into a stock that the manager thinks will perform well. Leverage can significantly boost returns, or it can utterly destroy profits. If there’s a situation where a lender calls on their own, investors in the hedge fund can experience massive losses as managers are forced to sell their securities in a falling market to raise cash to pay the lenders. This is exactly what happened in the market downturn of 2008.
