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Questions:

  1. What is a Hedge Fund?
  2. Why is it called a "hedge" fund?
  3. Who manages hedge funds?
  4. How are hedge fund managers compensated?
  5. Who is eligible to invest in hedge funds?
  6. Are there hedge funds that require lower minimum investments?
  7. What are the risks of hedge funds?
  8. What strategies do hedge funds use to make money?
  9. How liquid are hedge funds?
  10. What are some of the benefits of hedge funds?


Answers:

  1. What is a Hedge Fund?
    A hedge fund is a private investment fund that is generally "unregulated" or permitted by regulators to undertake a wider range of activities. Generally, hedge funds are open to a limited number of professional, institutional or wealthy investors. Hedge funds have a manager that uses alternative investment techniques, such as short selling, margin investing, debt, commodities and derivatives. A hedge fund typically pays a performance based fee to its investment manager. Top fund managers typically beat the general market performance and a manager with talent can furnish large capital returns not only for his investors but also for the manager himself.
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  2. Why is it called a "hedge" fund?
    Hedge funds were conceived as a way to generate positive investment returns regardless of market direction. As the name implies, hedge funds often seek to offset potential losses in the principal markets they invest in by hedging their investments using a variety of methods. However, the term "hedge fund" has come to be applied to many funds that do not actually hedge their investments, and in particular to funds using short selling and other "hedging" methods to increase rather than reduce risk, with the expectation of increasing return. To that end, hedge funds can sell short, trade in options and futures and use other strategies to hedge against market risk. However, hedge funds have become more varied in style and some, while still called hedge funds; do little to no hedging against market risk.
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  3. Who manages hedge funds?
    Historically hedge fund managers are entrepreneurs who invest a large portion of their own money in a particular investment strategy and gather additional money from a handful of private clients to help take advantage of the buying power of a larger magnitude of funding. Now, however, large mutual fund companies have entered the hedge fund business partly to stem the loss of top performing managers to the higher pay of top hedge funds, and partly to service and satisfy investor demand.
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  4. How are hedge fund managers compensated?
    How managers are paid is as diverse as hedge funds themselves. However, managers typically charge a management fee of 2 percent, but are often (sometimes preferably) rewarded for how well they execute the fund objectives and the achievements of fund performance. In some scenarios a hedge fund manager can receive 20 percent or more of the fund's gains, so long as the fund achieves a certain return goal first. If a hedge fund manager believes in his performance/product the manager will usually invest their own money in the fund -- a further reward for positive performance.
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  5. Who is eligible to invest in hedge funds?
    Hedge funds are not public offerings, therefore there are general restrictions on who can invest. Traditional hedge funds are open to wealthy investors; generally those who have at least $1 to $5 million in liquid net worth. Further restrictions may sometimes include a minimum investment threshold. What's more, some hedge funds to avoid additional regulation, limit the number of investors to 99 or less. While the above is typical, it is not the case 100% of the time. Each Hedge may determine its eligibility requirements for the fund depending on its management, size, financial condition and regulations preferences. Research and investigation is necessary in any specific hedge fund to determine your eligibility.
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  6. Are there hedge funds that require lower minimum investments?
    Recently, a number of hedge funds have reduced their minimum investment to attract new capital and gain greater financing. In a few cases some hedge funds have lowered initial deposits to as low as $25,000. Net worth requirements can be lower in some hedge funds depending upon the objective and target market. A few of these new hedge funds are structured similarly to regular mutual funds. There are also hedge funds of funds, where one hedge fund invests in multiple hedge funds yet is still bought and sold as a single fund account. Inquire into the minimums of your intended hedge fund. In some cases, a request for a small "test" account may result in the manager accepting smaller investments in an effort to gain a big investment in the future. Most managers have discretionary power to lower minimums.
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  7. What are the some of the risks of hedge funds?
    Like other business there have been cases of hedge funds that have lost money due to the fraud, negligent or incompetent activity of the fund's manager. Arguably these problems stem from a lack of regulatory oversight of the hedge fund industry. However, most poorly run or overly risky hedge funds can easily be spotted by doing due-diligence and asking a lot of questions. As with any investment, make sure that certified annual audits conformations are provided to you. A healthy performance track record is imperative. Third party oversight, third party valuation and the use of a custodian trust is always a plus. Remember any investment can lose money and risk is not necessarily tied to reward.
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  8. What strategies do hedge funds use to make money?
    There are a tremendous variety of hedge funds, each pursuing its own strategy. However, some popular strategies fall into three categories: Relative-value strategies try to profit from inefficiencies in a market or between different markets. Volatility and correlation to the stock market tend to be low. Examples include fixed-income arbitrage, convertible arbitrage and market neutral. Event-driven strategies try to take advantage of special situations such as mergers and bankruptcies. Volatility and correlation to the market tend to be higher compared to relative-value strategies. Examples include merger arbitrage, risk arbitrage, distressed investing and bankruptcy investing. Opportunistic strategies are directional and correlate more strongly to the market. Examples include macro trading, short selling and emerging markets investing. The above is for illustration purposes only, and is not meant to be an exhaustive list of strategies.
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  9. How liquid are hedge funds?
    Hedge funds and funds of funds are generally constituted as open ended investment funds. Therefore, their liquidity depends on the frequency in which they deal (i.e. issue and redeem) their shares and on any notice requirements imposed by the fund in order to deal. Most hedge funds have monthly liquidity with about 35 days notice, but some hedge funds are a lot less liquid.
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  10. What are some of the benefits of hedge funds?
    Including hedge funds in a balanced portfolio may help improve overall risk-adjusted returns often have a low correlation to the stock market Managers generally employ a wide variety of investing techniques to pursue absolute returns no matter how the market performs. They may have low volatility compared to the market, except for those employing certain high-risk strategies Managers receive incentives to perform well, which can further align the manager's interests with those of the investor A hedge fund of funds seeks to diversify among hedge fund strategies and managerial skill, and provides details about the risks, strategies and performance of the funds it holds.
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