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Hedge Funds: Risks Vs Returns

Apr 21st 2015 at 11:13 PM

If you are attentive to finance and marketing, you have probably gone through Hedge Fund News. Depending on your purpose, the term hedge can use as a verb, or a noun. Whether it is a product you purchase, or a deed you take, hedge is done to offset or minimize financial risk. A person who is purchasing a hedge is called hedging. A hedge is basically an investment that is not available for everyone because it has minimum sophisticated qualifications. It is made not to take advantage of a situation, but to offset or prevent risk or uncontrollable situations.

Qualifications of Investors

Investors of Hedge funds are required to have net worth of at least $1 million annually. They need this to ride out considerable downturns. They should also be able to keep their assets tied up for the 3 months.

Why Do They Invest in Hedge Funds

Large investors put 20% of their assets, while for more conservative investors, such as insurance companies, sovereign wealth funds, and pension funds, allocate only 10% of their investments. These people invest because they want to be protected, or if possible offset or minimize the risk.

Hedge Funds Rewards

  1. Managers of hedge fund are rewarded as a percentage of the returns they make. For most investors, this is the major attraction. There are those that are frustrated on the paid fees of mutual funds, regardless of the fund’s performance. Thanks to this compensation structure, managers become well-driven individuals in achieving above-market returns.
  2. Hedge fund managers concentrate in using refined derivatives, like futures options, contracts, and collateralized debt obligations. Even when the stock market is going down, the derivatives enable hedge fund managers to earn. They can even sell stocks short, or put options.
  3. Since hedge funds are not regulated compared to stock market, they tend to have spent in high returns, but tentative, financial vehicles.

Hedge Fund Risks

  1. Managers of hedge funds are paid by a percentage of funds' returns. But, if the fund loses money, managers will always get nothing no matter how much money they lose on hedge fund database – this is an absolute risk because investors can potentially lose all the money they invested in the fund.
  2. Leverage is one of the derivatives on hedge funds that are very risky. Within a certain window of time, options must be delivered. If there is a completely unexpected and unforeseen economic event that will happen during that period, the manager will lose the investment. In line with this, managers should try to time the market.
  3. As repeatedly stated, the lack of regulation means earnings of hedge funds aren't reported to the SEC or other regulatory bodies. Even though hedge funds are forbidden from frauds, this matter creates a potential risk. In addition, investors of hedge funds are part owners of LLC, which means they could lose their investment if it goes bankrupt as a business.

There is always a risk when it comes to doing business. Stock markets, for example, do have risks. Hedge funds investment is promising, but as soon as you invest, you should understand the whole concept better so that you will be able to take advantage of the rewards, and if possible, avoid the risks.

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