By Anusha Gupta
With the growing popularity and accompanied criticism for hedge funds, they are becoming a frequently used term in finance today. Often misunderstood as “sophisticated” financial jargon, hedge funds, in reality, aren’t that difficult to understand.
A hedge fund is simply an investment partnership set up by a manager. It can take the legal form of a limited liability partnership or a limited company, which means that if the company or the partnership goes bankrupt or is liquidated, then the creditors cannot drag the personal assets of the investors for the repayment of losses. The manager of the hedge is typically the person who has created it. She/he earns money as a percentage of profit earned on the money deposited by the investors. As a thumb rule only individuals or institutions with significant assets can invest in hedge funds. This means that the initial investment required is very high, which is why the “Aam Aadmi” does not have access to it.
In simple terms, hedge funds are mutual funds for the super rich. Like mutual funds they are pooled investments and are professionally managed, the difference between the two is in the flexibility in investment strategies and regulation. Hedge funds are currently unregulated by the US Securities and Exchange Commission (SEC); however the word on the street is that we may see a law on their regulation soon. Since hedge funds are relatively unregulated, they use various types of investing techniques, which are riskier as compared to mutual funds.
Another thing to keep in mind about hedge funds is that they are the complete opposite of hedging. It is important to note that hedging is actually the practice of attempting to reduce risk or eliminating negative impacts on profits due to unexpected price changes but the goal of most hedge funds is to maximize return on investment.
Here’s hoping that this article hedges away any doubts on hedge funds!
Views presented in the article are those of the author and not of ED.