Hedge funds: myths and reality

It is generally said that the first known hedge fund was an investment partnership established more than 60 years ago by Alfred Winslow Jones. There are various definitions of hedge funds in use, but broadly speaking, a hedge fund is any type of investment company or private partnership that uses the following instruments and techniques:

• •    Long or short positions across asset classes;

• •    Derivatives, such as options (call or put), futures, swaps, etc.;

• •    Financial leverage.

In addition, hedge funds often share the following characteristics:

• •    They are often formed as an unregulated investment pool and are generally domiciled offshore;

• •    They usually charge a performance fee;

• •    They require high minimum investments;

• •    Hedge fund managers usually invest their own capital along with their clients[1].

One of the biggest misconceptions about hedge funds is that they must take excessive risks in order to gain higher returns. The best hedge funds are specialists at minimizing risk and make it an integral part of their investment plan. Conscientious risk management serves to limit losses and promotes more consistent, generally higher risk-adjusted returns. Here are some myths and realities about hedge funds:

Myth: Hedge funds are only for wealthy private investors.

Reality: This idea belongs to the past. Today, even retail clients can invest in hedge funds.

Myth: Hedge funds are very risky and highly volatile.

Reality: The primary objective of hedge funds is to preserve capital by minimizing volatility, which has historically been much higher on stock markets than with hedge funds[2].

Myth: Hedge funds lack transparency in their portfolios and organization.

Reality: Nowadays, most hedge funds provide investors with monthly reports containing appropriate financial details. Pressure from institutional investors has helped to increase transparency.

Myth: Hedge funds are always unregulated investment vehicles.

Reality: Although true for many offshore hedge funds, numerous investment managers are regulated by local authorities such as the SEC in the US and the FSA in the UK. Hedge funds regulation is a widely discussed matter among financial authorities in today’s world.

Myth: Hedge funds use significant leverage.

Reality: Less than 30% of hedge fund managers employ a leverage effect greater than 2x (source: Van Hedge Fund Advisers International).

Misconceptions about hedge funds often arise from their complex nature and the lack of transparency that still prevails in this industry. Investors often regard hedge funds as “black boxes” that are risky by nature but offer high potential returns. However, over the long-term, hedge funds tend to generate better risk-adjusted returns than traditional asset classes[3].

"Экономика и социум" №2(15) 2015