Before attempting to understand hedge fund advantages and disadvantages, one must first understand what a hedge fund is and how it works.
Hedge fund managers help to maximize returns by incorporating a wealth of knowledge and experience into their techniques, strategies and recommendations.
A hedge fund is a type of alternative investment which is exclusive by nature and helps to provide diversity to an investment portfolio. Access is not granted to the public and it is only made available to special groups such as those who possess significant assets, or institutions. Currently, hedge funds are not regulated, and this allows their use in both traditional and non-traditional securities.
The idea of a hedge fund can be inferred from the word “hedging” which is a term that implies reduction of risk. There are varied investment techniques employed in tandem with investment in various assets, with the intention of generating higher returns at a given level of risk than is generated via normal investments.
Now that the nature of a hedge fund has been established, the next step is to understand the benefits of same. The benefits expressed here are just a subset and are by no means exhaustive.
Access to expert advice – Hedge fund managers help to maximize returns by incorporating a wealth of knowledge and experience into their techniques, strategies and recommendations. Their advice takes into consideration market behavior (which they are adept at forecasting), what hedge funds are applicable for use, and even the best locations for investment.
Risk management – Hedge fund investments aim to generate returns by having a balanced and market neutral approach to investment. These investments can be long-term or short-term, and there is also usually a wide array of investments involved. The method and the variety both allow for protection from the harsh negative impact of volatility and downturns in the market. The idea is that while some level of impact may be felt, it is lessened in comparison to that which is felt in a similar situation with normal investment vehicles.
Flexibility – Government regulators only lightly pay attention to hedge funds because they are not publicly traded. This is the reason for the allowance of various investment techniques and types. Additionally, there are no performance indicators that need to be measured against benchmarks.
Nothing is without its disadvantages and hedge funds are no different. Here are a few of the cons of hedge fund investment (these are also not exclusive). Investment fees – There are two distinct fees involved in hedge fund investing. The first is usually paid monthly, and is 2% of the fund’s net value. The second and more exorbitant is the performance fee which is 20% of what is earned in a year.
Lack of transparency – With hedge funds, no public disclosure is required. This means that neither regulators, nor investors can keep track of the activities of hedge fund managers, meaning that there is no indication of detrimental activities.
Liquidity – While mutual funds are more liquid and accessible, hedge funds stand at the opposite end of the spectrum. Usually, investors must leave money locked away for years without access.
Hedge funds are not necessarily for everyone even if access is granted. Before deciding to go this route in investment, the inner workings as well as hedge fund advantages and disadvantages must be reviewed and understood.