Mathematical explanations for the world mark modern finance, and wherever math is, you’re bound to see symbols and variables.
You don’t need to know all of the equations that shape financial theory, but you’ll have a leg up if you know the Greek letters used to describe different sources of risk and return. Keep this list handy when investigating hedge funds:
Alpha: Investment return that’s different than you’d expect, given an investment’s beta, which is its exposure to market risk and return. In the hedge-fund world, alpha is used to describe the value that the fund manager adds and the extra return generated for the amount of risk that the fund takes.
But remember, alpha can be negative, meaning that the fund manager subtracts value from the fund. Some researchers aren’t sure that alpha exists at all.
Beta: The amount of risk in the overall market portfolio. The market beta is 1, so an investment with a beta of more than 1 is riskier than the market as a whole. You’d expect the investment to return more than the market in an up year and less than the market in a down year.
If beta is less than 1, the investment is less risky than the market, and if beta is negative, the investment moves in the opposite direction.
Delta: The percentage change in an investment. Delta is often used to describe how much an option changes in price when its underlying security changes in price.
Gamma: The rate of change in delta. Gamma is exposure to any change in price, positive or negative.
Sigma: Represents standard deviation, or the likelihood that any one number in a series — like a series of investment returns — will be different from the return that you expect. The higher the standard deviation, the greater the investment risk.
FAQs
Hedge funds use pooled funds to focus on high-risk, high-return investments, often with a focus on shorting — so you can earn profit even when stocks fall.
What is the 2 and 20 rule for hedge funds? ›
The 2 and 20 is a hedge fund compensation structure consisting of a management fee and a performance fee. 2% represents a management fee which is applied to the total assets under management. A 20% performance fee is charged on the profits that the hedge fund generates, beyond a specified minimum threshold.
What is the minimum income for a hedge fund? ›
Hedge funds typically require an investor to have a liquid net worth of at least $1 million, or annual income of more than $200,000. They often borrow money to use in an investment.
What are hedge funds in simple terms? ›
Hedge funds are actively managed funds focused on alternative investments that commonly use risky investment strategies. A hedge fund investment typically requires accredited investors and a high minimum investment or net worth. Hedge funds charge higher fees than conventional investment funds.
How do hedge fund owners get paid? ›
Key Takeaways
Hedge funds make money as part of a fee structure paid by fund investors based on assets under management (AUM). Funds typically receive a flat fee plus a percentage of positive returns that exceed some benchmark or hurdle rate.
Can I start a hedge fund with my own money? ›
Yes, you could start with much less capital, or go through a hedge fund incubator, or use a “friends and family” approach, or target only high-net-worth individuals. But if you start with, say, $5 million, you will not have enough to pay yourself anything, hire others, or even cover administrative costs.
What is considered a good return for a hedge fund? ›
Most hedge and private equity funds target a net IRR of 15% for their investors (after fees). This provides their investors with a meaningful premium over historical average stock market returns of 8%.
How much net worth do you need to have to be in a hedge fund? ›
While hedge fund investors have no set average income, many high-net-worth individuals (HNWIs) who invest in hedge funds have annual incomes exceeding $200,000 or net assets of at least $1 million, excluding their primary residence.
Can you start a hedge fund with a million dollars? ›
There's no real prescribed target, but you should aim to have at least $5 million in AUM to be successful, while $20 million will make you noticeable to investors. Having $100 million will get you noticed by institutional investors.
Who Cannot invest in a hedge fund? ›
You generally must be an accredited investor, which means having a minimum level of income or assets, to invest in hedge funds. Typical investors include institutional investors, such as pension funds and insurance companies, and wealthy individuals.
BlackRock manages US$38bn across a broad range of hedge fund strategies. With over 20 years of proven experience, the depth and breadth of our platform has evolved into a comprehensive toolkit of 30+ strategies.
How much capital is needed to start a hedge fund? ›
With respect to establishing a U.S. hedge fund, average hedge fund startup costs range from $50,000 to $100,000, and first- year operational costs usually total $75,000 to $150,000.
What is one disadvantage of a hedge fund? ›
Hedge funds are risky in comparison with most mutual funds or exchange-traded funds. They take outsized risks in order to achieve outsized gains. Many use leverage to multiply their potential gains. They also are unconstrained in their investment picks, with the freedom to take big positions in alternative investments.
What is the ROI of a hedge fund? ›
Based on recent data, the average annual return on investment for investors in a typical hedge fund is around 7.2%, with a Sharpe ratio of 0.86 and market correlation of 0.9. However, it's important to note that performance can vary significantly among different hedge funds.
Do hedge funds make a profit? ›
How do hedge funds make money? Hedge funds take a management fee of between one and two per cent of the amount you invest. In addition, the hedge fund manager will receive a performance fee (usually around 20 per cent on any profit).
How much money do you need to start a hedge fund? ›
With respect to establishing a U.S. hedge fund, average hedge fund startup costs range from $50,000 to $100,000, and first- year operational costs usually total $75,000 to $150,000.
Why are hedge funds so secretive? ›
Hedge funds are fighting for secrecy because it “creates greater opportunities for insiders and others to exploit the rest of the markets,” said Tyler Gellasch, head of Healthy Markets, a trade group that includes pension funds and other asset managers.
How does a hedge fund make money on a short? ›
To short a stock, a hedge fund will borrow shares of the stock in question (usually from their prime broker) and sell them to other investors who are willing to pay the market price. Then, as the stock price falls, the hedge fund will buy the same shares at a lower cost and pocket the difference.
