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Many people have heard the term hedge fund, but most people have no idea what they are. Even those who have spent years investing in the stock market and other securities do not really understand the concept of a hedge fund.
It is a type of limited partnership where the fund manager acts as the general manager and the investors are the partners. One of the biggest differences between hedge funds and regular mutual funds is that hedge funds are not regulated. To avoid the rules, investors in the fund must be called “qualified purchasers”. The requirements for this are spelled out in the Investment Companies Act. Generally, a hedge fund investor must have a net worth of $1,000,000 or an annual income of more than $200,000. The government established this requirement to protect small investors from the high risk of hedge fund investing. By establishing those requirements, the chances of someone losing their entire worth are somewhat reduced.
Like any investment, the goal is to get the maximum possible return on investment. It often does this by investing in somewhat risky propositions such as stressed assets, derivatives and junk bonds. If the strategy is successful, huge returns can often be accomplished. But one wrong decision can wipe out the entire portfolio. Two popular hedge fund strategies are short selling and high leverage. Short selling is basically betting that the market will move in one direction or the other. Leverage simply means throwing a lot of assets at an investment in an attempt to influence it in a certain way.
Because these strategies are so risky, investors should fully understand how their particular fund manager plans to invest capital. Unlike other investments that allow you to be hands off and let the manager make the decisions, hedge fund investors are expected to be very active and involved in the process. If things go really wrong, managers want to make sure you know exactly what’s going on every step of the way. If the manger seems secretive or controlled, perhaps you should look for another fund. For example, if you work in the health care industry and see a future where costs keep rising while profits fall, would you want your fund manager to invest all his money on the big profits of the health care industry? put it on It’s part of being an informed investor.
The biggest advantage of this investment is the lack of regulation. Fund managers can invest in virtually anything, regardless of range or security. They are renowned for purchasing distressed properties and turning them into profitable real estate investments. It also takes over distressed businesses and helps reorganize them into profitable companies. This type of investment can provide dramatic returns on invested capital that are not possible with other safer forms of investment. Buying assets that are tied to debt allows a hedge fund to buy those assets for pennies on the dollar.
Hedge funds are one of the most attractive opportunities in a bear market. Opportunities to buy failing companies and other assets abound and with some good research the assets can be turned around and revitalized.
With the opportunity to make a lot of money comes the opportunity to lose a lot. Hedge funds aren’t for everyone, but if you can handle some of the risk, the rewards can be plentiful.
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