Written by: Patrick Lillie
Did you know according to some estimates that at the end of 2010, there was over 2.8 Trillion dollars worth of assets under administration or that there are nearly 12000 hedge funds? Do you even know what a hedge fund is? Before I blog about anything that I actually do at Equinoxe, there are probably many of you (if not all) that have next to no idea what a hedge fund is.
A hedge fund is an investment partnership that uses certain investment strategies and invests in a variety of assets to generate a higher return for a given level of risk than what you could expect from normal investments. Make sense yet? Probably not. So basically, you have a hedge fund manager who runs the fund. He is the head of the fund and decides what investment techniques and things he will invest the money of his fund in. Along with the manager, you have the investors. Investors can be people like you, me or they can be; however, to be a shareholder of a fund you must be an accredited investor (which we all hope to be someday).
An accredited investor (by United States standards):
a) a net worth of $1 million, alone or with a spouse
b) earned $200,000 in each year of the past two years
c) earned $300,000 in each of the past two years with a spouse
Each Hedge fund can be worth anywhere from a few million to tens of billions of dollars. That being said, there is huge money in this industry. In fact, many hedge funds are registered offshore in places such as Singapore, Cayman Islands, British Virgin Island, Bermuda, and Ireland to avoid higher taxes that make a significant difference on their large sums of money. Most people want to invest in hedge funds because everyone wants the high returns funds have to offer for the same risk as other ways to invest their money. How is this achieved? Each manager sets up his fund differently. They use different investment strategies to achieve their risk and return goals. There are a bunch of strategies that managers may use, but two notable features that managers use are derivatives and leveraging. I will to the best of my ability describe these (its actually kind of hard); however Investopedia may be a better source for the definitions.
Derivatives: Financial instruments such as options, futures or swaps (these are different ways of investing) that get their value from the value of an underlying asset. Essentially, they choose a predetermined price for which they choose to buy shares for as you are basically holding this financial instrument that has no intrinsic value of its own.
Leverage: borrowing money for trade. This increase risk a lot, but usually, the return is worth it. Leveraging typically goes hand in hand with derivatives. Investopedia example of leveraging: Most companies use debt to finance operations. By doing so, a company increases its leverage because it can invest in business operations without increasing its equity. For example, if a company formed with an investment of $5 million from investors, the equity in the company is $5 million – this is the money the company uses to operate. If the company uses debt financing by borrowing $20 million, the company now has $25 million to invest in business operations and more opportunity to increase value for shareholders.
Now that you know some of the basics, I will get be able to explain the work I am doing in later blogs.