Hedge fund
Hedge funds are specialized investment portfolios designed primarily for wealthy and sophisticated investors. Managed by a general partner, hedge funds require high minimum initial investments and employ various high-risk investing strategies, often involving speculation. Unlike mutual funds, hedge funds are largely unregulated and operate with limited transparency, which allows them to pursue aggressive investment strategies without the same public reporting requirements. The concept of hedge funds originated in the late 1940s with Alfred Winslow Jones, who developed a long/short equities model aimed at minimizing risk by balancing long positions in expected rising securities with short positions in those anticipated to fall. Modern hedge funds typically operate on a "2 and 20 fee system," charging a management fee of around 2% of assets and an additional incentive fee of 10 to 20% of profits. While the hedge fund industry has experienced various growth cycles and downturns since its inception, it remains limited to accredited investors due to its illiquid nature and high entry costs. The reputation of fund managers plays a crucial role in attracting investors, distinguishing hedge funds from more accessible investment vehicles like mutual funds.
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Hedge fund
Hedge funds are a type of investment portfolio aimed at wealthy and sophisticated investors. The portfolio is managed by a general partner and funded by high minimum initial investments. The investing strategies employed by hedge fund managers are often quite risky, and sometimes involve a great deal of speculation. Unlike mutual funds—another type of managed portfolio funded by pooled investments—hedge funds are largely unregulated. Though there are limits set by the US Securities and Exchange Commission on the number of investors a hedge fund can have, and bans on public advertising, hedge fund managers are often exempt from filing public reports, and conduct much of their business out of sight of investors.
Overview
In the late 1940s, Alfred Winslow Jones—an Australian-born doctor of sociology and one-time US diplomat—hatched the idea for the first hedge fund while working on the editorial staff at Fortune magazine. Inspired by an article he was writing on investment trends, Jones devised a strategy for minimizing risks on long-term stock positions that has come to be known as the long/short equities model. Short selling involves the sale of borrowed securities at a certain price with the expectation that they will fall in value. When they do, the seller buys back the securities at their lower price, thereby generating profit. By taking long positions on securities expected to rise in value over time, and short positions on securities expected to devalue, the long/short model allows an investment fund to remain market-neutral. A negative market event will generate profit on the short, while a positive event will leave the long and short positions balanced out. This is where the hedge in “hedge fund” comes from.
Jones built his fund on a partnership structure in which a general partner manages the fund, while limited partners make investments, and are only liable for their paid-in amount. Modern hedge funds typically charge management fees of around 2 percent of assets managed. When the fund performs well—returning profits exceeding the fund’s previous high-water mark—an additional incentive fee is paid to the manager. It is this incentive fee that draws talented investment managers to the hedge fund world. A typical incentive fee is around 10 to 20 percent of the fund’s annual net profit. This 2 percent management fee and up to 20 percent incentive fee are commonly termed the “2 and 20 fee system.”
Though modern hedge funds bear little resemblance to the original investment style, they have retained the limited partnership and performance compensation components of the Jones model. The hedge fund industry experienced a surge of growth in the late 1960s, but went quiet by the mid-70s due to heavy losses incurred on risky leverage strategies. Another boom in activity came in the mid-1980s and lasted until the early 2000s, when, once again, massive losses and subsequent investor withdrawal forced a number of high-profile funds to shut down.
Hedge funds invest in equities, bonds, options, and other securities. Because they engage in speculation, hedge funds are more risky than the overall market. The reputation of the individuals or businesses that manage hedge funds significantly impacts the fund’s appeal to potential investors in the twenty-first century. Unlike mutual funds—which appeal to a broader base of investors—hedge funds are illiquid and require a high initial investment by accredited investors (financially sophisticated individuals who meet specific criteria that allows them to trade in nontraditional assets and securities).
Bibliography
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