I ve started learning about the market but I dont know what hedge funds are. Please explain
In: 17
They are basically investment companies that take on money from high net worth individuals/accredited investors and institutional investors, that have pretty free reign to invest where they see opportunity. It’s high risk, high reward investing because they can do everything from buy a company outright to investing in all sorts of exotic financial derivatives.
They manage peoples money and invest it. To invest in a hedge fund though you have to be an accredited investor because hedge funds have different types of risks than what ordinary people just trying to save for retirement should be exposed to. Many hedge funds have different goals but traditionally the purpose is to have consistent returns regardless of market conditions without traditional market exposure. They do this with derivatives, commodities and single stock investments ect.
Hedge funds are used to reduce portfolio risk. Let’s say you have an investment portfolio of NASDAQ stocks. Most days some go up and some go down. But on a few days, they all go down. Wouldn’t it be cool to have an investment that went up when they all go down. This investment wouldn’t have to do anything on days where they were balanced up and down. Even if this investment went down when they all went up, as long as it was a minority position in your portfolio you’d still be happier. The point is to consistently make modest gains by avoiding losses rather than go all in and try to make huge gains while risking large losses.
Hedge funds are that “contrarian” investment. The people who run them bet against stocks that seem to be going up and invest in other instruments with behavior contrary to the rest of the market.
Like gamblers who bet Don’t Come, people who run hedge funds are disliked by most people in the market, because they make a lot of money when everybody else losses money. But in terms of making money, being popular isn’t really required.
They are special investment funds that normally (1) only allow very rich people to invest in them, (2) have very large minimum investments, (3) use high-frequency trading methods (constantly buying and selling stocks and other investments at a very fast rate based on computer algorithms) as opposed to buying a few specific stocks and holding them long-term like a pension fund might do, and (4) pay extremely high salaries to their fund managers.
The key differences from a mutual fund or etf are 1) sophisticated investors, 2) often exotic investments, and 3) the fund borrows money to leverage gains, or, possibly, losses.
I’ll actually explain like you’re 5.
To **hedge** a bet means to limit or reduce the amount of money you lose.
The best and simplest example of a hedge is a simple coin toss. If you wanted to bet $5 on heads, how would you **hedge** that bet? We do it all the time, we say “2 out of 3 wins.”
We know that it’s a risk to bet only on heads, so we hedge it by increasing the number of times we flip the coin.
That’s not how hedge funds work, but the concept of minimizing a loss or maximizing a reward is the same.
Hedge funds protect one type of investment by combining with another type of investment.
To be specific and technical, hedge funds use derivatives to offset losses or maximize gains on *other* investments, so if one doesn’t pan out you don’t fall flat on your ass. In theory.
While on average, market goes up, they are cycles, and you want your money to be relatively constant and not swing up and down
When oil goes up, steel goes down;
When steel goes up, oil goes down.
You give a manager who is supposed to be good with math and buy a balance of steel and oil, and make sure in the long term you make 10% every year.
Steel and oil in this case represents things the ppl invest in that goes in different direction, hence “hedge”.
Other examples include, bonds and housing, gold and stocks,
At least, that’s was the theory. Any more explaining would not be for 5 year olds
If you’re good at investing or trading securities, you essentially have 4 options:
1. You trade for yourself and do whatever you want. It’s your money.
2. You can create a proprietary trading firm and hire employees that will help you trade **your** money. You don’t have any outside investors so you can avoid all the day-to-day headaches associated with that.
3. You can create a mutual fund. This allows you to accept money from the public but it’s **regulated**. People invest in mutual funds through their retirement accounts.
4. You can create a hedge fund. This allows you to accept money from outside investors but they have to be **accredited**. In other words, you can manage the money of wealthy people.
Compared to mutual funds, hedge funds can pursue more exotic investment strategies. They can long, short, trade options, invest in cryptocurrencies, trade the weather, gamble on who the next president is going to be among other things.
There are advantages to creating a fund versus managing your own money. When you manage your own money, *all of the risk is yours*. All of the gains and losses are yours. On the other hand, if you lose money as a hedge fund, the losses are spread across your investors. Hedge funds can charge their investors whatever they want to manage their money, but historically the going rate has been “2 and 20,” meaning an unconditional 2% management fee and 20% of annual profits (if there are any).
Hedge funds take money from wealthy investors and invest them. There are many types of funds, but in general, hedge funds have two major differences:
(1) Only rich people can invest (i.e. accredited investors and institutions).
(2) They can short. Meaning they can bet that a company/stock/market will go down and profit from that outcome.
Hedge funds typically specialize in what they will invest in or how they will invest. Whether that is a specific style (e.g. quantitative, fundamental), product (e.g. stocks, derivatives, fixed income), or sector (e.g. technology, healthcare).
Attempting a *true* ELI5 here:
Most people on the stock market buy company-bits as low as they can, and then hope to sell them higher, so they’re hoping the cost goes up all the time.
Hedge funds have found a way to make money even when prices go down: Instead of buying stock, they borrow it.
Let’s say they look at Robinhood, and say, “people *hate* that guy, that’s going to hurt his stock price!” Then a guy says, “no, they’re too big and easy to use, I bet they’ll be fine.”
They say, “I’ll take that bet. I’ll borrow your stock shares from you, and I’ll pay you rent on them until I return them in a week or a month.” The other guy is happy, because he ‘keeps’ his stock and still gets paid.
The Hedge fund gets to *sell* the shares he just borrowed at the current price, and if all goes well, he can buy them back at half that in a week or a month, and just *keep* the rest of the money he got from selling the shares(minus the “rent”).
This can get even crazier with all sorts of dastardly tricks that can be used to sell the same borrowed shares over and over without even buying them again, through the magic of *intentionally bad bookkeeping*, but that’s a whole other ~~strategy~~ *tragedy.*
Latest Answers