What Is a Hedge Fund
What do hedge funds do?
There is a common perception that hedge fund managers are high-risk gunslingers, and some of the high-profile managers you see on TV match that description. For example, Pershing Square's Bill Ackman fits that mold. He tends to run a concentrated portfolio with large positions in just a handful of stocks.
But many hedge funds are distinctly conservative and pursue low-volatility strategies. Even the name "hedge fund" implies hedging, or risk reduction.
There are literally infinite strategies that hedge funds can pursue, and some combine different ones into "multi-strategy" portfolios. But here are some of the more common strategies you're likely to see in a hedge fund:
Long/Short: A long/short strategy is a relative value strategy in which a manager buys assets they believe will rise in value and sells short strategies that they believe will fall. For example, a manager might be long $Microsoft (MSFT.US)$ and short $Apple (AAPL.US)$ in the belief that Microsoft will perform better than Apple regardless of which direction the general market moves. This strategy aims to profit from both rising and falling markets.
Global Macro: Global macro funds take a big-picture approach, making bets on major economic and geopolitical trends. These bets can include currency positions, interest rate plays, and commodity investments. The legendary George Soros was the prototypical global macro manager, as his most famous trade was "bankrupting" the Bank of England by shorting the British pound in the early 1990s.
Event-Driven: Event-driven hedge funds focus on specific corporate events, such as mergers and acquisitions, bankruptcies or restructurings. These are closely related to "activist" funds that buy controlling positions in companies in order to force changes to management or the board of directors.
Arbitrage: Arbitrage strategies involve taking advantage of price discrepancies in different markets or securities. For example, a manager could buy gold in London and sell it in Shanghai if gold were trading cheaper in London.
There is a common perception that hedge fund managers are high-risk gunslingers, and some of the high-profile managers you see on TV match that description. For example, Pershing Square's Bill Ackman fits that mold. He tends to run a concentrated portfolio with large positions in just a handful of stocks.
But many hedge funds are distinctly conservative and pursue low-volatility strategies. Even the name "hedge fund" implies hedging, or risk reduction.
There are literally infinite strategies that hedge funds can pursue, and some combine different ones into "multi-strategy" portfolios. But here are some of the more common strategies you're likely to see in a hedge fund:
Long/Short: A long/short strategy is a relative value strategy in which a manager buys assets they believe will rise in value and sells short strategies that they believe will fall. For example, a manager might be long $Microsoft (MSFT.US)$ and short $Apple (AAPL.US)$ in the belief that Microsoft will perform better than Apple regardless of which direction the general market moves. This strategy aims to profit from both rising and falling markets.
Global Macro: Global macro funds take a big-picture approach, making bets on major economic and geopolitical trends. These bets can include currency positions, interest rate plays, and commodity investments. The legendary George Soros was the prototypical global macro manager, as his most famous trade was "bankrupting" the Bank of England by shorting the British pound in the early 1990s.
Event-Driven: Event-driven hedge funds focus on specific corporate events, such as mergers and acquisitions, bankruptcies or restructurings. These are closely related to "activist" funds that buy controlling positions in companies in order to force changes to management or the board of directors.
Arbitrage: Arbitrage strategies involve taking advantage of price discrepancies in different markets or securities. For example, a manager could buy gold in London and sell it in Shanghai if gold were trading cheaper in London.
Be careful with hedge funds
There are a few warnings that come along with investments in hedge funds.
The first is cost. Hedge funds often have high fees. A 2% management fee and 20% performance fee are not uncommon. Of course, those fees might be absolutely justified if the manager is doing something unique and the returns are within your expectations even after paying the fees. But if the manager is executing a strategy you could just as easily replicate in an exchange-traded fund (ETF) or mutual fund, it's hard to justify paying a premium.
You should also be aware of potential lockups. Unlike mutual funds, which generally have daily liquidity, and ETFs, which can be sold any time the market is open, hedge funds may only offer liquidity on a monthly or quarterly basis, and even this can be subject to conditions.
There are a few warnings that come along with investments in hedge funds.
The first is cost. Hedge funds often have high fees. A 2% management fee and 20% performance fee are not uncommon. Of course, those fees might be absolutely justified if the manager is doing something unique and the returns are within your expectations even after paying the fees. But if the manager is executing a strategy you could just as easily replicate in an exchange-traded fund (ETF) or mutual fund, it's hard to justify paying a premium.
You should also be aware of potential lockups. Unlike mutual funds, which generally have daily liquidity, and ETFs, which can be sold any time the market is open, hedge funds may only offer liquidity on a monthly or quarterly basis, and even this can be subject to conditions.
Disclaimer: Community is offered by Moomoo Technologies Inc. and is for educational purposes only.
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