“What are hedge funds, exactly?” You have probably asked yourself this question at least once in your life. Sure, we read about them in the newspaper and/or online. We hear about them on television and how some people are making millions of dollars by managing them. But what are they? What do they consist of? Are they just another scam or can you really build a consistent, livable income from them?
By definition, a hedge fund is a portfolio of aggressive investments that utilize extremely advanced investment strategies such as long, short, leveraged and derivative positions in all markets – in an effort to generate high returns.
-Still confused? That’s because the aforementioned explanation could mean just about anything.
If we do a little more digging, we will find that most hedge fund managers today, take on the role of risk managers, investment bankers, venture capitalists and currency speculators.
That being said, I think we can safely conclude that the term ‘hedge fund’ (or h-fund), and the people that manage them, cannot be easily defined – at least, not to the point that the idea can be quickly communicated. However, if we were to sum things up in a more generalized way that is easier to understand, we could simply say that a hedge fund manager, in the investment world, is just another ‘consultant’.
You may find that, some of the more intelligent managers on Wall Street have decided to manage their own h-funds. Of course, that makes sense because by managing your own h-fund, you have the freedom to manage the money as you see fit while making money for yourself and for your investors. So, it’s a win-win situation.
Many times, h-funds are managed in such a way that they see a consistent level of return – regardless of the current marketplace. Many h-funds are designed to reduce risks; hence, the word ‘hedging’. Typically, seeing a higher return on your investment usually means that you’re going to see greater risks. However, many times, h-fund managers are able to reduce the associated risks without cutting into the investment capital. For example, said manager may have ways of avoiding/reducing risks while taking on other investors/investments that are expected to see a good return. A good example of this is when the h-fund manager borrows money in an effort to increase his/her return on a low-risk investment. This process is known as leveraging. It is important to know how h-fund managers make their money if you are interested in investing in h-funds.
There are always going to be risks associated with these types of investments – no matter how you see it. This is the unfortunate truth. It’s not a simple task to eliminate risks while gaining a return on any investment. This is the challenge that all hedge fund managers face. This is also why h-fund managers are able to make great money if they are successful and/or have a successful track record.
Hedge fund managers typically see a management fee and a performance fee (i.e. incentive fee) from any/all funds that he/she manages. The management fees are usually around 2% of the fund’s net asset value (annually). The performance fees can be as much as 20% of the fund’s profit. And considering the fact that there are many h-funds that are currently being backed by multimillion dollar investments, you can probably understand why hedge fund management can be (and is) so lucrative. Which brings me to my next question -”how can I get started”?
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