April 13, 2006
Understanding Hedge Funds
Those who are in the industry don’t need any introduction to hedge funds and their functioning. But if you are an outsider trying to understand the industry, the whole thing may seem very confusing and difficult. So, here’s a quick crash course for those who want to understand the market and hedge funds. You tend to hear a lot of talk about using hedge funds when the stock market is doing poorly. This makes people mistake hedge funds for mutual funds. This is a big mistake and must be remedied immediately. Firstly, let us examine the name. The word ‘hedge’ suggests defensive management or an insurance against bad times. But in reality, hedge funds come in hundreds of varieties and often use leverage.
So, how does one differentiate between hedge and mutual funds? You probably have a slight understanding of mutual funds. So, let understand hedge funds by examining the differences between these two types of funds. One of the first things you will notice is that while mutual funds are regulation SEC registered investment vehicles, hedge funds are not regulated and are private investment vehicles. Investments in mutual funds need not be very high – they can be reasonable. However, with hedge funds, large minimum investments of around $1 million are required.
Another thing is that hedge funds form exclusive clubs. In other words, while mutual funds are available to the public, to deal in hedge funds, you must be an accredited investor. To become an accredited investor, your net worth must exceed $1 million or your individual income must have been in excess of $200,000 in the past two years. You must also expect the same level of income in the current year.
In case you consider yourself a potential hedge fund investor, here’s a word of caution. Information on hedge funds is still not easy to come by, and there is quite a bit of misinformation floating around. So, it is important that you study the market first before taking the plunge.
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