A hedge fund is an offshore investment fund that is formed as a private limited partnership that engages in speculations making use of credit or borrowed capital. Hedge funds explore every available market and they make use of various investment strategies and financial instruments.
One thing about hedge funds is that it can be very volatile; the risk involved is much and the profit margin is much as well. As a matter of fact, hedge fund is one of the world’s top investment vehicles and you stand to get good returns on your investment annually if you invest in hedge funds.
Hedge fund operates with little or no regulations from the United States of America Securities and Exchange Commission (SEC). As a matter of fact, hedge funds cannot be sold to the general public just like mutual funds.
The concept and term ‘Hedge Fund’ were created by Alfred Jones in 1949. He founded A.W. Jones, which is a partnership with four friends, and through this investment vehicle, they were able to invest one hundred thousand U.S. dollars ($100,000) in the stock market.
They employ both long and short positions. The bottom line is that they were able to generate 17.3 percent returns during the first year of investment and that was enough to set the ball rolling for hedge fund investment. This is one industry that you can make a lot of money from. As a matter of fact, in the United States of America, the hedge fund industry is estimated to be a $1.2 trillion industry with approximately 9,000 active hedge funds.
Research shows that the largest – top 25 hedge fund managers had an estimate of $520 billion in assets under management. Amongst the list are Bridgewater Associates, Paulson & Co., and Soros Fund Management. Please note that Hedge Funds Investment is not open for all because it requires large capital to invest in it. The amount required to invest in hedge funds could range from 1 Million US Dollars to even multiple Million Dollars.
Each Hedge fund managers have their requirements, so just ensure that you save up large amounts of cash that can meet the investment requirement of the average hedge fund you can find. Having said that, let us look at some of the areas where hedge fund firms make money.
2 Smart Ways Hedge Funds Make Money
Management Fee and Performance Fee
Hedge fund firms are known to generate income by charging both a management fee and a performance fee from their clients. On the average, hedge fund firms charge between 1 percent and 2 percent of assets under their management annually, and the performance fees are about 20 percent of gross profits returned by the fund which is usually based on certain constraints.
If you run a hedge fund firm, the easiest way for you to make money is to help your clients make more money. The income you generate is based on your performance which is why most hedge fund managers employ different investment strategies to generate good returns for their clients. In other words, the performance fee is indeed the defining characteristic of a hedge fund.
In essence, hedge funds make money as part of a fee structure paid by fund investors and this is based on assets under management (AUM). This funds typically receive a flat fee plus a percentage of positive returns that exceed some benchmark or hurdle rate.
Returns on Diverse Investment Vehicles
Although this is similar to management fee and performance fee, but hedge fund firms can also make money by reinvesting their income and also by offering equity long bias, equity long-only, equity long/short and equity market neutral funds, fixed income funds, emerging market funds, event-driven funds, multi-strategy funds, macro funds and by offering distressed securities funds.
Please note that on the average, hedge fund firms employ strategies that can help them reduce market risk specifically by shorting equities or through the use of derivatives. This is why many hedge fund strategies, mostly arbitrage strategies, are limited as to how much capital they can successfully employ before returns starts diminishing. Little wonder most successful hedge fund managers place a limit on the amount of capital they will accept per time.
Despite the high volatility of the market, investors still choose to invest in hedge funds because of the huge returns on investment they stand to gain if they get it right
Hedge funds are known to provide access to a wide range of investment styles, strategies, and hedge fund managers for one easy-to-administer investment. Hedge funds provide more predictable returns (depending on the objectives of the fund of funds) than traditional investment funds and it provides effective diversification of investment portfolios.