I’ve been trying to follow the Wall Street bets situations, but I can’t find a simple definition of hedge funds. Help?
In: Economics
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You and I as individual investors can trade a company’s stock, bonds, commodities etc. on a public market.
Then there are investment companies which offer pooled funds, where we can put in money and they will bundle it together and trade common securities (stocks, bonds etc.) for us, hopefully getting positive returns while saving us from having to do the work ourselves. There are different types of such funds, mutual funds being the most common – either actively managed by an investment manager or tracking some index like the S&P 500. The basic idea is to buy hundreds or thousands or more securities together to not be affected by fluctuations in a single one.
Hedge funds take things up a notch. They are specialized and exclusive versions of mutual funds open only to institutional investors or very high net worth individuals. They are also far less regulated than publicly accessible funds. Hedge fund managers use very aggressive investment techniques and invest in a wider array of products than just stocks or bonds – like options and other derivatives, real estate, currencies, art, precious metals or really anything else that can be bought and sold. They often use large amounts of borrowed money (aka leverage) and so are generally exposed to a lot more risk than normal funds. They also frequently take short positions (bet that a stock will go down instead of up) in order to “hedge” against market downturns or take advantage of failing companies.
Worth noting though that while the name “hedge fund” originated in the 50s and 60s because such funds would optimize their investments to reduce risk, today’s hedge funds are mostly the opposite. It’s more and more just a generic label used by private funds with varying (and sometimes opposite) goals and investment strategies.
**There is no such thing as a “hedge fund”**
These firms should be called by their proper name: **Speculative Funds**. They make high risk (and often highly leveraged) gambles in the securities markets, using hedging tools and techniques that were originally meant to mitigate risks (such as shorts, options, futures, and other derivative securities).
They are much less regulated than traditional investment banks (JP Morgan, etc) and as such operate under the radar. They also appeal to high net worth individuals.
A famous Speculative Fund, Long Term Capital Management, nearly caused a systemic collapse years ago. It was run by some of the most brilliant Financiers and Economists to ever live, which stands to this day as a testament that even the geniuses cannot predict everything.
And that is what we are seeing with GME these days. A large number of Speculators gambled with very wealthy people’s money and underestimated the number of people who also knew how to play their games. And more importantly play those games against THEM.
And they are pissed, because peasants are not supposed to beat them at their own games.
Actual ELI5:
A normal fund invests in stocks and bonds. Basically you invest in cash-generating machines, which makes a lot of sense long-term. But nothing else is allowed.
A hedge fund may invest in anything, usually derivatives but can really be anything. This is **more like taking bets**. So they take a bet with someone else on the market. “We think this cash-generating machine will generate _less_ money next year” and someone is on the other side of the bet. This is much more risky, includes different regulation, may go in the opposite direction of the market (hedge) and is not long-term in itself since it needs new bets continuously.
Everyone here’s taking way too long to explain it.
Wall Street bigwigs like to short stocks. This means borrowing a bunch of them and selling them off, but you agree to buy them back at a certain point in time.
When you do this, you want the stock to tank in value, so that when you buy them back, you pay much less, leaving you with a large profit. Wall Street hedge funds, which are the bigwig’s mutual exchange fund, tried to short GameStop stocks. r/wallstreetbets retorted; they’re a group of small time investors and circlejerkers who artificially inflated the moribund company’s value by purchasing shares en masse. They essentially turned GameStop into a Fortune 500 company overnight, and the Wall Street bigwigs actually took a loss for once.
Imagine you ask your mom to borrow her watch for a week. Now you tell your little sister that the watch is worth a lot of money, and she pays you a lot of money for it. A week later, you come back to your sister and tell her the price for a watch isn’t so high anymore, and ask if you could buy the watch back for a low price. Now you give the watch back to your mom, after making money off of it without really doing anything.
That’s what hedge funds do, except on a bigger scale and with stocks instead of watches. They borrow the stocks, sell them when they’re expensive, buy them back when they’re cheap, and make millions.
What hasn’t been mentioned is that the general public is not allowed to invest in hedge funds unless you have something like a million liquid lying around. Hedge funds exist solely to richen the rich without any public benefit.
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It is a private pool of funds from accredited investors that can be invested however the managers see fit, as long as they can raise the money. They are loosely regulated because of accredited investor rules. Basically, the wealthy investors must (should) know what they are getting into.
Hedge fund managers can be aggressive, conservative. Basically whatever they want to do that is ‘legal’.
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