Hedge Funds

Hedge Funds

The term hedge fund covers a very wide range of types and styles of fund.

The basic principle is that the managers have a very high degree of autonomy concerning investments.

They can pretty much do anything they want with investors money, (including, for example, creating completely new companies to buy and run, and hopefully later sell at a profit), and it is absolutely essential that you read and fully understand the documentation concerning the specific fund in which you invest.

Background

The term hedge fund is historic – a hedge is a financial device that allows you to protect a position if the market falls, (as in to hedge your bets). For example a UK company agreeing to pay $1,000,000 (for the sake of argument equivalent to £500,000) on a certain date next year for supplies might be worried that the pound might fall, making the supplies more expensive. So they use a hedge, they pay a small fee that allows them to buy their million dollars for no more than £550,000. They are said to have hedged their exchange rate exposure.

The original hedge funds realised that they could use various financial instruments to make money in a falling market, as well as in a rising one (so long as they made the right decisions).

Hedge funds have a degree of glamour associated with them because for many years only the very rich could invest in them, and in the days of easy credit (BNR – Before Northern Rock, aka up to summer 2007) they developed a reputation for making huge profits for their mangers, and for having the financial clout to move markets.

But as with all investment – ignore the glamour, make sure you understand their record, their methods, and the risks.

Last updated on April 06, 2012