Hedge funds are popularly known as rich man’s mutual fund due to their high capital requirement. These funds are in the business of making money for the “Top 1%” out of thin air, and thus, the topic has become fascinating for many now. The funds are handled by a hedge fund manager, and his firm would generally be registered as a Limited partnership business, in which two parties are included GPS and LPs. GPS stands for general partners and are fund managers, and LPs stand for limited partners, who are investors.
Today, we’ll study some brief concepts related to hedge funds, top traps to avoid in it, and a short comparison with mutual funds.
Understanding “Hedge Funds”
A hedge fund is a pooled investment vehicle, and the term consists of two different words, i.e. “hedge” and “funds”, the meaning of which are:
- Hedge In financial terms, hedge means protecting yourself or your money in times of uncertainty or risks.
- Funds Here, it means a pool of funds collected for investment in the financial market from different sources, like individuals with high net worth, through varied sums of money.
Hedge Fund Managers
Hedge funds are collected by fund managers, and they invest the sum into different asset classes, which are areas in the market for investment, like fixed income, equity, multi-asset, etc. The reason why these funds are infamously popular among people with high net worth is that they can bet in both directions, i.e. long and short. Therefore, in situations like a market crash or depression, the “hedge funds” protect (or hedge) against the losses by going short.
Red Alert Scam Hedge Funds: 3 Traps to Avoid
- High Return Funds One common error that investors often carried out is falling for funds that offer high profits that have never happened before. However, fund managers with high returns take more risks compared to others. This is a significant gap that is getting bigger every day. And, because of the bad habits of these people, most of the hedging fund managers are also trying to get the best return. However, understand that if they lose, your payment will be lost, and if they win, they will get a good piece of your profits.
Example: Let us assume we have two options, one, funds with an ROI of 25% with a risk of 40% and second, funds with an ROI of 5% and a 2% risk. Most people here will choose the first because of the high yields. - Big Bubble Funds Big Bubble is the next type of high return trap & is a common trap where beginners and experienced investors fall. Here, the fund manager invests aggressively and takes high risk. As a result, they get high ROI. But, this is not a volatile pool; In fact, this continues to grow until the market falls. However, these managers build large bubbles by investing aggressively, and when bubbles explode, their value falls sharply.
If we try to imagine the growth chart, it will look like growing for a long time and then falling suddenly. - Hostility Selection A detrimental choice is a situation when someone tries to sell something to you without providing complete information about the product or service. If someone tries hard to sell their combined hedging funds, then there may be a little shortcoming in it. The reason is that the hedging fund manager does not need to prove their value, and people believe in them from the beginning.
For Example - People who choose life insurance are that people who have health problems or follow anti-healthy lifestyles. These people hide their true health from insurance companies (people with hostile or detrimental choices).
Hedge Funds V/s Mutual Funds
Most investors often get confused between hedge funds and mutual funds. While the two are utterly different in growth, strategies, and objectives, there are certain similarities between the two too. Let us start by understanding the basic meaning first:
- Hedge Funds Hedge funds are the pool of investments collected from high net worth people and investing that fund into different asset classes to earn profit. Note that hedge funds are good passive income sources.
- Mutual Funds Mutual fund is also an investment fund vehicle where anyone can invest their sum of money, and the funds are invested in the equity market to make gains. The earnings are equally divided among the people after deducting the fund manager’s commission.
Both mutual and hedge funds use pool investment vehicle to collect funds from different individuals and invest to earn profits.
Top Differences between Mutual and Hedge Fund
- Hedge funds are suitable only for people with HNI (high net worth individuals), and no common man can start investing in it. Also, the amount required to spend on these is huge. Mutual funds are suitable for everybody, and the amount required to start investing in them is also meager.
- Hedge funds invest their collected funds in different asset classes. It could be anything from the start-up to the real estate, from stocks to mutual funds; a hedge fund manager enjoys the leverage to diversify his portfolio in whatever way he wants. In contrast, a mutual fund manager is limited to spend his investments according to the client requirements. Some mutual funds only invest in equity, while some only in currencies.
- Hedge funds are a riskier form of investment as compared to mutual funds due to various factors. The top reason can be hedge fund managers use high margin while spending, and the investors have no control over them.
- Hedge fund managers charge a high fee for their investment, which generally varies between 15-30%. In comparison, mutual fund managers charge a meager commission on profits earned.
So, this was all about hedge funds and not every person can get into it. However, with the help of a good broker, you can invest your money into diverse asset classes, like fund managers. One has the option to invest in shares, commodities, crypto, indices, metals, currency pairs, and ETFs.
Good Bye LineOverall, hedge funds are riskier but provide high return to people with above-average net worth. The world is growing, and new alternate methods to invest your money are coming up daily. However, the most critical point is to clear the basic fundamentals of every investment option. Some of the top ways to learn are reading books, attending seminars, and binge-watching quality videos.
Generally, inflation takes the 10-12% leap every year, and one needs to earn more than this to beat it, no matter which investment option you choose. If you are making less return than this, then you’re falling back.
