Events across the globe impact your investment performance, whether it be war or prospects of a new pandemic or recession.
Investors desire steady returns with low volatility. Certain classes of investors, such as pensions or endowments, must meet their monthly financial obligations regardless of market conditions.
Hedge funds are investment vehicles designed to deliver consistent returns with low correlation to broad-based indices. Hedge funds charge significantly higher fees than most investment vehicles. The hedge funds that deliver this performance profile are worth the cost to institutional investors.
What is a hedge fund?
Hedge funds are investment funds that pool capital from accredited high-net-worth individuals or institutional investors and invest in a variety of assets, often with complex strategies and risk management techniques. Unlike mutual funds, which are subject to a broad range of regulatory restrictions, hedge funds are typically more flexible in their investment strategies.
Hedge funds often use dynamic strategies that are unavailable to mutual funds, including short selling, leverage, arbitrage, derivatives, and swaps. The goal is to achieve positive returns regardless of the market environment.
What a hedge fund aims to do:
- Increase the value of the fund’s assets over time.
- Protect fund capital through diversification and hedging strategies.
- Take advantage of price discrepancies in and between markets.
- Provide returns that do not follow the trends of traditional markets.
- Use unique strategies that produce income, such as fixed-income arbitrage or distressed debt.
How do Hedge Funds Differ from Traditional Investments?
There are a few key differences between hedge funds and investments as you know them. The main differences lie in the strategies they employ, the regulations they face and how they typically react to the market at large.
Strategies
Hedge Funds: Employ a wide range of strategies, including long-short equity, market neutral, arbitrage, macro-trends, and event-driven plays. They can use leverage and derivatives to amplify returns. Hedge funds can give exposure to alternative investments and strategies, such as commodities, derivatives, and currencies, which are not typically available in traditional portfolios.
Traditional Investments: Typically use a long-only strategy, buying assets with the expectation that they will increase in value.
By including asset classes and strategies not found in traditional investments, hedge funds can potentially lower overall portfolio risk.
Market influences
Hedge Funds: Hedge funds aim for high alpha, which is the return above the benchmark or market average, often through the use of leverage and concentrated positions. With the flexibility to move in and out of different markets and positions, hedge funds can capitalize on opportunities regardless of market direction.
Traditional Investments: Since traditional investments cannot short sell, they cannot take advantage of changing or shifting market conditions. Traditional investments also lack the dedicated funds to form concentrated positions on the level of hedge funds, limiting the strategies they can use to protect from downside risk and market volatility.
Regulations
Hedge Funds: Only accredited investors can invest in hedge funds - but this has resulted in fewer regulations. The lighter regulation allows for more flexibility in investment choices, Without the regulatory constraints that bind mutual funds, hedge funds have the flexibility to invest in a broader range of financial instruments and to adjust their investment strategies as market conditions change.
Traditional Investments: Highly regulated regarding what they can invest in, how much leverage they can use, and how they market themselves. This ultimately ties normal investments to how the market reacts to world events.
Liquidity
Hedge Funds: Hedge funds usually have lock-up periods, meaning investors cannot withdraw their money for a certain period.
Traditional Investments: Can often be purchased with lower minimum investments and have market or daily liquidity. This makes them accessible to the average investor.
To summarize:
| Hedge Funds | Traditional Investments | |
| Strategies | Wide range of strategies | Long-only strategy |
| Regulations | Less regulated | Highly regulated |
| Liquidity | Lock up periods | More liquidity |
| Investment Minimums | High minimum investment | Low minimum investment |
| Market influence | Low market influence | High market influence |
What makes hedge funds ideal for investment managers, corporations and insurers
For investment managers, investment corporations, and insurers, hedge funds can be attractive as they help them manage large pools of capital, achieve specific investment objectives, and adhere to their fiduciary responsibilities.
For investors with the capability, hedge funds represent the potential to generate positive returns, often referred to as absolute returns, regardless of market conditions.
Besides this key advantage, there are additional reasons major accredited investors find hedge funds appealing:
Diversification
Hedge funds often engage in strategies that are non-correlated with traditional stock and bond markets, which can help to diversify risks. They provide access to alternative asset classes and strategies, diversifying away from traditional equities and fixed income.
Risk Management
Hedge funds can employ various hedging strategies to protect against downside risk. Their ability to use strategies and come out ahead in challenging markets helps bring essential risk management to portfolios.
Access to Sophisticated Strategies and Instruments
Hedge fund managers often have specialized knowledge and experience in particular markets or strategies. They also allow the opportunity to invest in complex instruments like derivatives, which can be used for speculation or to manage risk.
Liability Matching
Insurers might use hedge funds as part of an asset-liability matching strategy, where the cash flows from hedge fund investments are used to match the payment of claims or policy liabilities.
An investment tool for accredited investors
Hedge funds represent a dynamic investment vehicle for accredited investors. There are thousands of hedge funds to choose from. Resonanz Capital offers an experienced investment team to advise, assist and manage hedge fund investments for institutional investors.
