Understanding Hedge Funds
Hedging is the practice of attempting to minimize risk. In the simplest terms, hedge funds are complex investment vehicles that seek to achieve higher rates of return and offset potential losses by taking alternative investment positions through short selling, arbitrage, and other tactics.
Hedge funds are not regulated with the same intensity as other investment vehicles because they are deemed private offerings as defined by the Securities Act of 1933. These funds are not required to register with the SEC, nor must they submit the type of periodic reports required of public companies, mutual funds and the like. Until recently, hedge fund opportunities were largely available only to institutional investors and the affluent because of the substantial minimum investment required. With the advent of funds of hedge funds – investment vehicles that invest in solely other, multiple hedge funds to balance risk and rewards – significantly lower minimum investments, sometimes as low as a $25,000, have made hedge funds accessible to a greater number of investors.
Potential hedge fund investment strategies include:
- Investing in equities, bonds (including mortgage backed securities), options, futures, commodities and illiquid investments;
- Hedging by buying a security to offset a potential loss on an investment;
- Investing in distressed or bankrupt companies;
- Concentrating positions in securities of a single issuer or market;
- Investing in derivatives, such as options and futures contracts;
- Short selling (sale of a security you do not own);
- Investing in volatile international markets;
- Arbitrage (simultaneous buying and selling of a security in different markets to profit from the difference between the prices);
- Investing in privately issued securities.
Hedge funds aren’t limited to any particular financial market and often leverage assets (borrowing money for investment purposes) to maximize profits. While this approach often leads to significantly higher returns, the strategy is fraught with risk – particularly when coupled with the considerable amount of speculative investing that takes place – and has lead to many funds’ collapse. Our firm understands the nuances of this highly specialized market niche, and the all-too-common ways that investors can be deceived or under served.