Hedge Fund 101 (2)

Management characteristics

The high leverage of investment effects, the complexity of investment activities, the private nature of financing, the secrecy and flexibility of operations. Hedge funds have become a synonym for a new investment model. That is, based on the latest investment theories and highly sophisticated financial market techniques, they take full advantage of the leverage of various financial derivatives. Take high risk. Investment model that seeks high returns. Hedge funds have the following characteristics.

Complexity

With the increasing complexity and variety of financial derivatives, such as futures, options, swaps, etc., becoming more and more popular among hedge funds. primary operating instrument. These derivatives were originally designed to hedge risk, but because of their low-cost, high-risk, high-return characteristics, they have become the primary instrument of choice for many modern hedge A powerful tool for funds to engage in speculative behavior.

Hedge funds use these financial instruments in complex portfolio designs to invest according to market forecasts, taking excess profits when forecasts are accurate, or to design investment strategies that take advantage of the disequilibrium created by short-term mid-market fluctuations to take advantage of spreads when markets return to normal conditions.

High leverage

Typical hedge funds often use bank credit to borrow at extremely high leverage (Leverage) on their original fund volume of basis several or even dozens of times to expand the investment capital, thereby maximizing returns. The high liquidity of a hedge fund's securities assets allows the hedge fund to use its fund assets to easily make mortgage loans.

A hedge fund with a capital of only $100 million can lend up to billions of dollars by repeatedly collateralizing its securities assets . This leverage exists so that after a single transaction, net of loan interest, the net profit is far greater than if only $100 million of capital had been used. potential gains from the operation. Likewise, and precisely because of the leverage effect, hedge funds often face a significant risk of excessive losses if they do not operate properly.

Private Placement

Hedge funds are generally structured as partnerships. The fund investor enters the partnership with capital and provides the majority of the capital but does not participate in investment activities; the fund manager enters the partnership with capital and skills and is responsible for. investment decisions of the fund.

Because hedge funds require a high degree of secrecy and flexibility in their operations, hedge funds in the U.S. are generally limited to less than 100 partners, and each partner's capital contribution is more than $1 million (the rules for hedge funds vary from country to country, for example, hedge funds in Japan are limited to less than 50 partners, etc.).

Since hedge funds are mostly private, they circumvent the strict disclosure requirements of U.S. law for public funds. Because of their high-risk nature and complex investment mechanics, hedge funds are prohibited in many Western countries from soliciting funds from the public in order to protect the interests of ordinary investors.

In order to avoid high U.S. taxes and SEC regulation, hedge funds operating in the U.S. markets are generally registered offshore in some low-tax, loosely regulated areas such as the Bahamas and Bermuda, and are limited to raising funds from investors outside the United States.

Concealment

Hedge funds and securities investment funds for general investors not only differ in terms of fund investors, fund raising methods, information disclosure requirements, and the fact that they are subject to the same rules and regulations as other investment funds. The degree of regulation varies considerably. There are also many differences with respect to the fairness and flexibility of investment activities.

Securities investment funds generally have a clearer definition of their asset mix. That is, there is a defined scheme for the selection and proportionality of investment instruments, e.g., a balanced fund refers to a fund portfolio that is roughly 50/50 stocks and bonds. Growth funds refer to investments focused on high-growth stocks; at the same time, mutual funds may not use credit facilities to make investments, and hedged The Fund, on the other hand, has no such limitations or definitions at all and can use all available financial instruments and portfolios to maximize the use of its resources. (b) Credit funding to generate excess returns above average market profits.

Hedge funds play an important role in speculation in modern international financial markets due to the high degree of secrecy and flexibility in their operations and the leveraged finance effect.