What is a Hedge Fund?

Hedge Funds

Hedge Funds

Hedge Funds are types of partnership investment opportunities. Sometimes these are formed as a limited partnership or a limited liability company just in case the company goes under or bankrupt, creditors will not be able to try to get more money from the investors than the amounts they contributed to the hedge fund. These are a very risky type of investment which many shy away from while others flock to it. Some feel that the greater the risk the higher the return can be in the end. A hedge fund manager will use money that has been deposited with his company by investor and use it to invest in another company looking for a profitable return on the funds.

The main purpose of a hedge fund is to capitalize on the market and be able to make money whether the market is increasing or decreasing.  This type of private investing is a way to sort of outperform the market. This type of private investing is not like mutual funds which are run by large public corporations; therefore they are not regulated by entities such as the Securities and Exchange Commission (SEC). This lack of regulations is what makes them be so risky, but is also one thing that makes them more attractive to investors. This is just one type of private investing opportunities which companies such as Effi Enterprises helps locate for start up businesses or struggling companies.

What does a manager do?

Managers of a hedge fund get compensated by earning a percentage of the returns. This is more appealing to many investors since they do not get just a “fee” as a return on their investment. The managers stand to make a lot more profit since the compensation structure can yield a return that is above market value. Without the standard types of regulations, hedge funds can yield a very high return; even though much of the investment is based on speculative results initially. Managers are excellent at using derivatives, like futures contracts or options. These allow a manager to bring in a profit whether or not the stock market goes up or down. Many times they have the option of selling the stocks short which basically means they can use a small amount of money as leverage and remain in control of large quantities of commodities or stocks. And they can select a particular time frame in which they will pay out. This means that they can use timing along with leverage to make a huge return if they correctly predict if the market is going to rise or fall.

New Regulations on Hedge Funds

Recently, there were some new regulations put into place regarding hedge funds. If the hedge fund is valued over $150 million it must be registered with the SEC. The Dodd-Frank Wall Street Reform Act which was enacted in 2010 set up a Financial Stability Oversight Council which watches for this type of private investing that begins to grow too large. Once it is deemed that they are “too large to fail” the Council may recommend the regulating of these funds by the Federal Reserve. The Dodd-Frank Act also set limits for how much a bank can invest in a hedge fund. Hedge funds can only be used by banks on behalf of customers and not simply to boost the corporate profits of the bank.

What happens if the investment is lost?

The hedge fund is very risky for investors. If the investment pays off everyone gets paid, but what happens if the fund loses money? Does the manager still get paid? Absolutely not; they will not get paid if there is a loss. The manager is somewhat protected while it is the investor that stands to lose. However this type of investment is protected from fraudulent activity but many feel that there are not enough regulations in place that can help protect the private investor.

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About Efraim Landa

My name is Efraim Landa I am an entrepreneur and an expert in venture capital. I am the co founder of Effi Enterprises, a venture capital firm as well as the co founder and CEO of Gluco Vista, a company that is in the process of developing a non invasive glucose meter for those with diabetes.

Posted on July 14, 2012, in Finance, investing, IPO, Wall Street and tagged , , , . Bookmark the permalink. 1 Comment.

  1. This post was very informative. It provided great background information on hedge funds, as well as more in depth information such as new regulations for hedge funds. Glad I read it!

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