Question: What Are Hedge Funds?
Answer: Hedge funds are generally privately-owned investment funds, and so are not regulated like mutual funds whose owners are public corporations. Furthermore, hedge fund managers are compensated as a percent of the returns they earn. This attracts many investors who are frustrated by mutual fund fees that are paid regardless of fund performance.
Thanks to this compensation structure, hedge fund managers are driven to achieve above market returns. Since they get zero no matter how much money they lose, they are also very risk tolerant. This makes the funds very risky for the investor, who can lose much more than zero.
Hedge fund managers are very good at using sophisticated derivatives, such as futures contracts, options and puts. Basically, these products all do two things: they use small amounts of money, or leverage, to promise large amounts of stocks or commodities. Secondly, they all say they will deliver this stock or commodity at a particular point in time. In that sense, hedge fund managers are trying to time the market, which some would say is very difficult if not impossible to do.
Hedge Funds FAQ
- What Are Hedge Funds?
- Who Invests in Hedge Funds?
- How Do Hedge Funds Impact the Stock Market?
- How Do Hedge Funds Impact the U.S. Economy?
- What Was the LTCM Hedge Fund Crisis?
