Mutual funds are among the most popular investments on the market. There are over 8,000 of them holding over $4 trillion dollars. Many people buy them because of their competitive returns. Others like them because they are easy to buy and sell. Still others cite the fact that mutual funds, because they hold several investments, can spread risk.
A mutual fund raises money from investors to invest in stocks, bonds and other securities. It is a package made up of several individual investments. When those investments gain or lose value, you gain or lose as well. When they pay dividends, you get a share of them. Mutual funds also offer professional management and diversification. They do much of your investing work for you.
Mutual funds may be open-end or closed-end funds. The term "mutual funds" is used most often to mean open-end funds. Open-end funds issue new shares continuously as investors buy them. Investors redeem their shares directly to the fund, which in turn must buy them back. Closed-end funds issue a fixed number of shares that the fund may redeem only upon termination of the fund's trust. Shareholders in a close-end fund may, however, sell their shares through a broker on the secondary market to other investors but not back to the fund. This first section of this paper will focus on mutual funds. Followed by hedge funds
A hedge fund can be defined as an investment strategy that employs both long and short positions, uses leverage and derivatives, and is much less dependent on market direction than long-only investments such as stocks, bonds and mutual funds.
Hedge funds have a distinct advantage over traditional mutual funds in that broader and more sophisticated investment strategies can be employed in the pursuit of positive returns with lower volatility in both rising and falling markets.
Hedge Funds are not conventional investment funds and may use some of the following strategies:
Hedge Funds are not conventional investment funds and may use some of the following strategies:
A. Hedging by Selling Short: Selling shares without owning them, hoping to buy them back at a future date at a lower price in the expectation that their price will drop.
B. Using Arbitrage: Seeking to exploit pricing inefficiencies between related securities.
C. Trading Options or Derivatives: Contracts whose values are based on the performance of any underlying financial asset, index or other investment.
D. Using Leverage: Borrowing to try to enhance returns.
E. Investing in Out-of-Favor or Unrecognized and Undervalued Securities.
F. Taking Advantage of the Spread Between the Current Market Price and the Ultimate Purchase Price in Situations such as Mergers or Hostile Takeovers.
Some Hedge Funds don't actually hedge against risk or may use high-risk strategies without hedging against risk of loss. For example, a global macro strategy may speculate on changes in countries' economic policies that impact interest rates, which impact all financial instruments, while using lots of leverage.
The returns can be high, but so can the losses, as the leveraged directional investments (which are not hedged) tend to make the largest impact on performance.
Most Hedge Funds hedge against risk in one way or another, making consistency and stability of return, rather than magnitude, their key priority.
Event-driven strategies, for example, such as investing in special situations reduce risk by being uncorrelated to the markets.
Hedge Funds may buy interest-paying bonds or trade claims of companies undergoing reorganization, bankruptcy, or some other corporate restructuring - counting on events specific to a company, rather than more random macro trends, to affect their investment. Thus, they are generally able to deliver consistent returns with lower risk of loss.
Long/Short equity funds, while dependent on the direction of markets, hedge out some of this market risk through short positions that provide profits in a market downturn to offset losses made by the Long positions.
Market neutral equity funds, which invest equally in Long and Short equity portfolios generally in the same sectors of the market, are not correlated to market movements.
A true Hedge Fund then is an investment vehicle whose key priority is to minimize investment risk in an attempt to deliver profits under all circumstances.
Different Hedge Fund styles are as different from one another as are i.e elephants and crocodiles! So, too, are global macro funds and convertible bond arbitrage funds and Long/Short equity funds.
Different Hedge Fund strategies vary enormously in terms of their returns, volatility and risk. Therfore, some hedge funds, which are not correlated to equity markets, are able to deliver consistent returns with extremely low risk of loss, while others may be as, or more volatile, than certain mutual funds.
Hedge funds may be more accessible than ever, but that doesn't mean anyone can get in. The SEC still requires investors to fulfill certain criteria before purchasing alternative investments, such as fund of funds. Client must fits at least one of these definitions before investing in hedge funds.
Accredited Investor: Someone with over $1 million net worth, or an income over $200,000 for the last two years (if married, $300,000). These investors may invest in deals that are either limited to 100 investors ("Section 3-c-1" companies) or registered under the 1940 Investment Company Act (known as "registered funds").
Qualified Purchaser: Someone with at least $5 million in investments. These are the only clients eligible to invest in Section 3 (c) (7) companies, privately placed funds with no more than 499 individual investors.
Qualified Client: Someone with over $1.5 million net worth or $750,000 under the management of a single advisor. Many hedge funds prefer Qualified Clients to Accredited Investors.
