11 things you must know to understand hedge funds
Hedge funds are a mystery in themselves and have been for quite some time for people who are in the financial domain sector. Hedge funds are a good alternative investments but are generally not publicly and actively traded and known to people. These funds are for those having high industry expertise and a risk appetite for investment.
So here are some important points that one must know before starting to invest in hedge funds:
#1. High Net-worth Individuals
Hedge funds are meant for the big shots and the big players of the market. Minimum investment starts from 1 crore INR in a hedge fund which is a big amount for any class of person looking for investment and looking to park his funds for future.
#2. Huge Risk Appetite
Hedge funds have high risk high return mantra which is always not a demand from any investor looking to invest in the market. Every investor has a different risk- appetite for his funds on which he is expecting a stable return in the future.
#3. Complex Nature
They are not easy to understand and interpret as a variety of software and analytics is used to understand the working of Hedge funds.
#4. Portfolio of Securities
It is a portfolio of various types of securities that is present in the world. Hedge funds may be a combination of shares, foreign bonds, derivatives, foreign currency convertible bonds etc.
#5. Traditional and Non- Traditional assets
Hedge funds generally comprise of a large variety of non-traditional assets which are not exchange listed and rather are over the counter listed securities which are not generally much traded. As there is a huge profit margin in them, fund managers do enter into future and options contracts to hedge their position.
Leverage is equivalent to debt this is when people borrow debt in their books to leverage themselves to buyout or fund any transaction of any nature. Leverage is known as taking debt for any capex plan or acquisition or leverage buyout. However, it can also magnify a loss.
#7. Hurdle Rate
It is the rate of return that the hedge fund manager has to earn in his portfolio before the manager starts participating in the profits. Often, the Treasury bill rate or LIBOR is used.
#8. London Interbank Offered Rate (LIBOR)
The London Interbank Offered Rate is a daily rate at which the various banks lend to each other on an overnight basis when there is a shortage of cash occurrence in the account. It is also known as the risk free rate of return on an overnight basis. There are different rates for different period. In India just like LIBOR the credit is lend on MIBOR.
#9. Management Fee
The management fee is based on a percentage of the assets in the fund, which comes out to be 1% or 2% which is the prevailing market rate. In the hedge fund context, it is usually accompanied by an additional incentive, or performance fee.
#10. Lock-up Period
It is the number of years in which you cannot withdraw your money from the fund. Hedge funds generally comes with long lock up periods exceeding somewhere 10 years or more which gives you an opportunity to search for other avenues of investment rather than opting for hedge funds.
#11. Short Selling
Short selling involves the sale of a security which is borrowed one and is sold in the open market. The seller is not the owner of the security or the asset he is selling in the open market and is betting on the stock to go down or up as per the contract in which he has entered into. This is the practice that most of the hedge fund manager do who are expecting the stock or security not to perform well in future. They borrow the security and short-sell it in the open market at a particular time.
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