Hedge funds - A dark part of the financial world

Hedge funds gained household prominence during the financial crisis when a lot of them lost their money due to overleveraging. It’s for that reason that they got a bad rap. But they can also make their investors a lot of money, because they have much more freedom to move the money in and out of whatever assets they’d like.

Let’s start with the name. Hedge means to reduce risk, but the hedge fund’s aim is to maximize the return. At the time when the first hedge fund was being founded it aimed to protect against downturns by shorting the market. And so hedge fund was born.

What separates hedge funds from other mutual funds? Primary difference – not everyone can invest there. You are supposed to be a big time investor, earning at least $200k the past 2 years and have a net worth of $1 million, excluding your primary residence. Since they are riskier, it’s thought that you must be able to take massive financial blows.

Hedge funds are much less regulated – the general partners can invest in land, gold, stocks, bonds, you name it. They just have to tell their investors what they’re investing in. And they can short. Mutual funds on the other hand can only stick to stock and bonds.

But the most important is that they can use borrowed money to amplify their absolute returns. This could lead to massive profits out of a few moves, but also to huge losses if things go awry.

A point worth to point out is their aggressive way of investing – many times it’s just speculation and often it’s investing for a short time to benefit from singular upswings.

Today the hedge fund industry is growing fast, which currently $3.2 trillion are being locked in there. Among the most famous hedge funds are Citadel LLC, Paulson & Co and Soros Fund Management.

See also: Penny stocks – a speculator’s heaven

 

 

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