A hedge fund is an investment fund usually only available to a limited range of investors. They are not as closely regulated as other types of investment funds and as a result, they can use many more investment strategies and techniques. They are widely regarded as a high-risk investment but they try and pay back a high profit or return to compensate for this.
The investors pay fees to the partners of the hedge fund for using their investment expertise. Hedge funds have typically been paid a 2% management fee and a 20% performance fee. The management fee is always paid and it is calculated as 2% of the total assets under management (AUM). The performance fee is used to motivate the hedge fund to make as much profit as possible for the investors. The partners of the fund take 20% of the profit made by the fund during the year.
In recent years, hedge fund fees have come under increased scrutiny, particularly after the Madoff scandal of 2008, and the 2/20 model is no longer as prominent as it was. A lot of managers now run a 15/1.5 model for example. This is also due to the underwhelming performance that hedge funds have been returning over the last 5 years.
Traditional asset managers invest in a very straight forward manner – what is known as a long-only trade, in which they essentially make money when a stock goes up in price. The difference for a hedge fund is that they have the ability to trade using both long and short trades, meaning they can make money even when stocks go down.
Recently, due to an increase in fund regulation (what a fund can and cannot invest into by law), there has been a new range of hedge funds introduced called UCITS funds. They will generally charge on a smaller fee structure and will generally not generate the same level as returns, but is generally seen as being a much less risky fund to invest into. UCITs funds also offer investors greater liquidity, with daily reporting offered as opposed to the quarterly reports which offshore funds often offer.
There is a range of different investors which tend to invest money into a hedge fund. The larger the hedge fund, the higher calibre of investor they tend to attract.
There are a number of different strategies that a Hedge Fund will operate in:
Multi-Strategy; Involves a number of different strategies running in sync with each other. This is also called a platform approach, with a number of standalone PM’s running an individual portfolio which feeds into a master fund. Managers that run such an approach are Millennium, Point 72, Balyasny, Citadel and Bluecrest
L/S Equity; The oldest and most simple hedge fund strategy. A hedge fund will take equity in a company and hope to generate a return when the stock of a company moves. This can be in either a long or short position. Generally very liquid in nature. Some of the best L/S Equity hedge funds include Marshall Wace, Lansdowne Partners, Pelham Capital and Elliot Management
Credit/ Fixed Income; a more complex way of investing, which involves taking credit out on specific investments. This can be quite an illiquid way of investing and can often involve investing in the debt of a company. Credit sub-strategies include High-Yield, Distressed Debt, Direct Lending, Investment Grade, L/S Credit and Real Estate. Some of the largest credit managers in London include Davidson Kempner, Varde Partners, Apollo Management and Oak Hill Advisors
Event-Driven; crossed the border between equity and credit. Event-Driven managers generally invest in companies that have already filed for bankruptcy. Often influenced by worldwide events – political change etc. which influence economic decisions. Some of the best Event-Driven managers include Sand Grove, Melqart Asset Management and Sandell Asset Management
Global Macro; by nature, global macro funds can invest in any market globally. They take a macro approach as to how macroeconomic trends will influence markets globally and will then long or short accordingly. Global Macro is more volatile than other hedge funds. Some of the largest Global Macro hedge funds include Caxton Associates, Rokos Capital, Brevan Howard and Glen Point Capital
Systematic / Quant / CTA’s; a systematic way of investing. Funds will create algorithms and formulas which track markets and will invest automatically according to market movements. Trend Following. Some of the largest systematic managers include Two Sigma, D.E Shaw, Aspect Capital and MAN AHL
Hedge funds generally invest in either developed markets or emerging markets. Emerging markets can often be more volatile, but will generally yield higher returns.
TYPES OF HEDGE FUND INVESTORS
High Net Worth
(one person with a high amount of personal wealth)
High Net Worth
(a small team of investors who are tasked with managing a very wealthy family's money for them)
Fund of Hedge Funds
(used to be the biggest hedge fund investor, have shrunk a lot in size recently. They charge their own fees to invest money on behalf of large institutional investors but have been unable to justify the extra layer of fees recently)
(not an investor as such, but they advise institutional investors on their hedge fund investments and charge a flat fee. The most common source of direct investment)
(Pension Funds, Superannuation schemes, Universities, Sovereign Wealth Schemes, Private Banks (the best and biggest type of investors, who allocate much more single tickets into hedge funds)