If you’ve been involved in the financial world at all within the past ten years, you’ve probably heard of a hedge fund. Hedge funds are not actually a specific type of investment, instead it’s a type of investment structure where money is pooled and managed by a registered investment advisor. This investment structure is labeled as either a limited liability company or a limited partnership, however, limited liability companies have become much more popular within the past ten years. In this blog, we’re going to take a look at what exactly a hedge fund does and what it’s used for.
What Does A Hedge Fund Do?
Hedge funds can specialize in pretty much anything like real estate, junk bonds, common stock, and even buying out privately held businesses, improving their operations and sponsoring an initial public offering. In a hedge fund, the manager will get money from outside investors to invest in whatever strategy they use.
How It Works
Oftentimes, hedge funds will use something called a “long-short strategy.” This essentially means investing in both long positions and short positions (buying stocks or selling stocks with borrowed money). Once the stocks have been sold, they are bought back once the price has fallen. Derivatives are another common investment for many hedge funds. This refers to contracts for buying or selling security at a specific price.
Another more high-risk strategy is called leverage. This technique involves investing with borrowed money. This could lead to a significant increase in potential returns but is a lot riskier than some of the other techniques.
Hedge Funds Versus Mutual Funds
With a hedge fund, it’s much more difficult to sell your shares than with a mutual fund. The term for this is “liquid.” With a mutual fund, a net asset value is determined each day which will allow you to sell the shares any time you want. Conversely, hedge funds are often confined in what’s called a lockup period where shares cannot be sold.
Mutual fund managers are also paid differently than hedge fund managers. A money manager for a hedge fund is paid by their performance. A mutual fund manager is paid the same regardless of poor or good performance.
Don’t be fooled! Although some hedge funds have started with as little as $10,000, the additional costs that come along with that. This includes things like legal costs, administrative costs, investment compliance costs, tax and audit costs, technology, marketing, and more. This could add up to well over $100,000.
Contact Guardian Financial Group
Hedge funds are a pretty advanced form of investing and require a lot of experience to pull off correctly and start seeing returns. The top priority of our financial advisors is to create both short-term and long-term goals for you, as well as helping you be more strategic about your finances. This includes financial planning, retirement planning, tax planning, insurance analysis, and education funding and planning. Contact us today to learn more.