eli5, What are hedge funds ?


I ve started learning about the market but I dont know what hedge funds are. Please explain

In: 17

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.

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.

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.