The Little Book of Hedge Funds
Given their range of investment strategies, the goal of hedge funds is always absolute returns, not simply better returns than a benchmark index.
The investment strategies of a hedge fund include:
- Long/short equity
- Relative value
- Event-driven
- Direction
Don’t invest in a hedge fund whose manager doesn’t have skin in the game.
Unlike mutual funds and indices, hedge funds are generally only available to accredited investors.
An accredited investor must have at least a $1 million net worth excluding the value of their primary residence and/or make $200,000 per year.
An accredited institution must have $5 million in assets and/or be comprised entirely of accredited investors.
Hedge funds are not regulated by the SEC, hence them only being available to accredited investors.
Hedge funds can’t effectively manage as much money as mutual funds because they must remain nimble and flexible to changing market conditions.
In addition to a standard investment management fee of 1%-2%, hedge funds charge a performance fee of around 20% of profits.
Most hedge funds have lock-up periods that far exceed one month, so it would be unwise to invest too much of your portfolio in a hedge fund.
A lot of people think they are long-term investors until they experience short-term losses.
The term hedge fund is somewhat of a misnomer insofar as any fund that were perfectly hedged would not generate any returns.
The characteristics that make up a hedge fund:
- Fee structure where mangers receive a percentage of profits + a management fee.
- Long and short investing strategies.
- Multi-asset class portfolio strategy.
- Large co-investment by a general partner that lead to an alignment of interest.
Alpha is the measure of market performance relative to a benchmark index, and beta is a measure of volatility relative to a major benchmark index.
It’s not enough to just maximize returns, investors must look to maximize their risk-adjusted returns.
Uncorrelated returns = Controlled risk.
A hedge fund’s tendency toward long and short market exposure reduces directional bias and encourages market efficiency by closing the spread between overvalued assets and undervalued assets.
Relative value trades are the most effective in sideways markets.