What are Hedge Funds?

Hedge funds are not as well-known as mutual funds, and truth be told, these are still in their initial phase. While like mutual funds, these also pool their resources from various investors, they use a number of complex strategies to deliver high returns by “hedging” risk. In India, more and more people are coming to know about hedge funds and are investing in it.

What are hedge funds?

In the context of investing, hedging means to safeguard or to protect against risks. Hedge funds use money collected from insurance firms, banks, high net worth individuals and families, pension funds and endowments. Hedge Funds don’t have to register with SEBI or to be disclosing their NAV like other mutual funds.

A portfolio of a hedge fund consists of equities, derivatives, currencies, bonds and convertible securities. Thus, these are also seen as alternative investments. Hedge funds require aggressive management since they try to hedge or safeguard investor’s money from market risks and fluctuations. Hedge funds employ considerable leverage as well, unlike mutual funds, and hold both long and short term positions on the market.

Should you be investing in Hedge Funds?

Hedge funds are not handled directly by the investors like you. These are instead handled by designated managers who are experts in this field. Due to this reason, these are costlier than mutual funds. As you can understand, you can get hedge funds if you are financially well-off. This in turn is because trading in hedge funds requires an aggressive trader who can handle risks and has surplus funds.

The more structural complexity there is in these funds, the more the risks shall be. The manager needs to buy and sell at dizzying speed just to keep up with the market fluctuations, which is why his fee is as high as 15% to 20% of your returns. 

If you’re a first-time investor, it is better to stay away from hedge funds for now. You can always come back to them later when you have more experience. 

What are the Features and benefits of Hedge Funds?

Hedge funds were allowed from 2012 when SEBI allowed investment in alternative funds Hedge Funds have features such as: 

1. High net-worth investors: You can invest in hedge funds only if you are an accredited or qualified individual. Investors here mainly include banks, insurance companies, pension funds, endowments, high net worth families and individuals.

2. Diverse portfolio: Hedge funds are ruled by the concept that the investors’ money needs to be safeguarded from market fluctuations as much as possible. This is why hedge fund managers invest in a comprehensive portfolio including stocks, equities, currencies, derivatives, real estate and bonds.

3. Higher fees: In hedge funds, there is a concept of expense ratio and management fee. In India, the management fee can be below 2% and even below 1%. The profit sharing falls between 10% and 15%. 

4. Higher risks: The risks are higher since investment strategies can give huge risks to hedge funds. Besides, there is a long lock-in period when you can’t access your funds. 

5. Taxation: Income from hedge funds is taxable at your investment fund level. 

As you have seen, these funds have higher risks, but also give you a potentially higher reward when compared to mutual funds. However, you should still choose a fund carefully, and a fund manager with even more care.