What does the term "hedge fund" mean?
In essence, it is a managed pool of capital for institutions or wealthy individual investors that uses one of many trading strategies in stocks, bonds, or derivatives to try to profit from market inefficiencies and, to some extent, hedge underlying risks.
Most hedge funds are not as well regulated as other types of investment funds, and they are usually a lot less clear about how they work. This helps them trade without being seen. Most funds have minimum investment periods and charge fees based on both the amount of money they manage and how well they do.
Many experts think it's wrong to call hedge funds an asset class. Instead, they say, the industry is more like a group of trading strategies. The right hedging strategy for an investor depends a lot on what it already has in its portfolio. For example, if it has a lot of stocks, it might look for a hedging strategy to offset equity risk. Because of this, it can be confusing to talk about the relative returns of different hedge fund strategies.
Hedge funds invest in ways that most other funds can't, like "short selling" stock, which means borrowing shares to sell them and then buying them back later at a lower price, and using a lot of borrowed money to get a lot of leverage.
Most of the time, the best ways to do things change. People have said that the hedge fund industry was driven by equities, but in 2006, there are less equities and more long/short. In 2006, the picture seems to have a lot more variety and less of a concentrated exposure format.
Some of the most common ways to do this are:
Convertible arbitrage involves buying convertible securities (usually shares or bonds) that can be traded for another type of security (usually common shares) at a set price and selling the underlying stocks at the same time. This strategy used to work very well and was the norm. But this kind of action doesn't seem to work as well as it used to, and people don't seem to like it as much as they used to.
Emerging markets are when you buy sovereign or corporate debt and/or shares of a company in a country with an economy that is still growing.
Investing in a "basket" of hedge funds is called a "fund of funds." Some funds of funds only invest in one strategy, while others invest in more than one. Fees have been added to these funds.
Global macro is the practise of investing in changes between economies around the world. Often, derivatives are used to bet on changes in interest rates or currencies.
Market neutral: Usually, the same amount of money is put into long positions and short positions in the market. This is done to try to balance out risk by buying undervalued securities and selling short overvalued securities.
As you can see, the language used to talk about "hedge funds" is always changing and hard to understand.
You should be fluent in both the language and the ideas so that you can talk about investments and make smart choices instead of ones that you're not sure about.
Remember that if you don't understand and plan your investments well, you will be the one to pay for it in the end, not your broker or adviser.
