A word hedge means a strategy to protect an investment or portfolio against loss. Hedge funds use aggressive strategies for achieving maximum returns with minimum risks. A hedge fund is also called an alternative investment fund or AIF in India. A hedge fund doesn’t require registration with SEBI and it doesn’t have to disclose NAV periodically like a mutual fund.
What is Hedge Fund?
A hedge fund is a private investment instrument managed by money manager or fund manager. Hedge Fund make use of money collected from high net worth individuals (HNI), bank, insurers, pension funds etc. Hedge funds are very aggressive in nature. They take a lot of risks and invest money across multiple asset classes. The portfolio of hedge funds includes equity, derivatives, bonds, currencies and other asset class. They employ various strategies to maximize return and control risks. A hedge fund manager takes a lot of risks of buying and selling assets at lightning fast speed. An expense ratio of these types of funds is very high. If you have surplus money and your risk taking capacity is high you can invest in these types of funds.
A fund manager plays a crucial role in generating a return from this type of funds. Check for fund manager experience and expertise while shortlisting hedge funds.
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Key Features and Benefits of Hedge Funds
Key Features and benefits associated with hedge funds are given below.
Only for High Net worth Investors
These types of funds are only for high net worth investors, banks, insurance companies and pension funds. The minimum investment amount in these funds is 1 Cr.
Asset Diversification
Hedge Funds offers benefits of asset diversification. These types of funds invest in multiple assets such as equity, debt, derivatives, currencies, real estate, and bonds. Thus investor gets benefits of all asset class.
Higher Risk
Although these funds are intended to offer higher returns, a risk associated with these funds are high. Most of the hedge funds come with a lock-in period.
Higher Fees
The fee associated with this type of fund is very high. The hedge fund manager charges a flat 2% fees on the total asset value. Additionally, they take 20% profit fee on the profit earned. Some of the hedge fund ask for additional management fees which is very high.
Tax
Any income arising from these funds are taxable at the investment level. This means tax obligation will not be passed to the unitholders.
Regulations
Hedge funds are not regulated in nature. It is not mandatory to register fund with SEBI. These funds have no reporting requirements. Disclosure of NAV is not mandatory in these funds.
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Mutual Funds Vs Hedge Funds
Most of the people feel that hedge fund is similar to the mutual fund. However, both are different. Difference between a mutual fund and hedge funds are given below.
| Mutual Funds | Hedge Funds |
| Highly regulated by SEBI. Registration with SEBI required. | Not regulated by SEBI. Less stringent control & regulation. |
| Mutual funds are accessible to the large group of people. Investment amount requirement is very low. | These funds are available only to High net worth investors. Investment amount required for this fund is very high. |
| The mutual fund enjoys high liquidity. | Hedge funds have a lock-in for subscriptions and redemption. |
| Less costly – expense ratio is low. | Costly – Expense ratio is very high. |
| No leverage in Mutual Funds. | Increased leverage and speculative positions. |
| Mutual Funds are benchmark to index. | Not benchmark to anything. |
| Asset diversification is limited. | Asset diversification is very high. |
| Mutual Funds investment is less risky. | Hedge Funds are comparatively riskier. |
How Hedge Fund Works?
Hedge Fund uses multiple strategies for making money. Few popular known strategies used by a hedge fund are given below.
Short selling – The fund manager believes share prices will drop and sell shares with a buy-back in the future at a less price.
Arbitrage – The simultaneous buying and selling of securities in different markets to make a profit. You can buy and sell in the NSE and BSE to make a profit.
Making use of an upcoming event – In this case fund manager make use of upcoming events such as merger, acquisition, expansion or a spinoff for making a profit.
Look for a discount sale – Some Companies may be in deep distress or near bankruptcy and their shares fall. If it is opportunity buying fund manager takes a call after looking at advantages and disadvantages.
Points to consider while investing in Hedge Funds
Few important points to consider before investing in hedge funds are given below.
- These type of funds are for high net worth and experienced investors.
- Read the hedge funds prospectus carefully before investing.
- Know expense ratio and a fee associated with the fund.
- Know about lock-in period and redemption rules.
- Do careful research on fund manager associated with the fund.
Happy Investing!
