A Hedge fund is an investment fund that uses alternative investment strategies that are more complex and often riskier than a traditional collective investment scheme. These complex strategies aim to generate a positive return both when the market is bullish (positive) or bearish (negative) and include:
Derivatives (such as option, forward and swap) are often used by hedge funds to manage investment risks, to earn income or to speculate on the future direction of markets and assets.
Hedge funds often use borrowed money, as well as money from investors, to fund their trades and investments, or use derivatives for a similar purpose. This technique is called gearing or leverage. This increases their potential returns but brings additional risks for you.
Hedge funds often bet against future price increases in shares and other assets, using a strategy called 'short selling' or 'shorting'. For instance, if a fund manager is expecting the price of a share to drop, the hedge fund 'borrows' shares from another party and sells them at the current price. If the price falls as expected, the manager can then buy the shares back at the lower price and return the ‘borrowed’ shares, making a profit. However, if the shares price rises, the fund manager will have to buy the shares at a higher price in order to be able to return the ‘borrowed’ shares, thus making a loss.
Although everyone can invest in hedge funds these are mainly targeted towards institutions, such as pension funds, or high net worth individuals. Hedge funds can invest in a diverse range of assets, but they most commonly trade in stocks listed on a stock exchange. Hedge funds sometimes invest in assets other than conventional bonds, listed shares and investments, requiring a greater level of understanding of the risks involved by investors. Although each fund is different, two common features of these hedge funds are their complexity and investment strategy.
WARNING: HEDGE FUNDS ARE RISKY. BEWARE. Last updated: Sep 07, 2016