What is a hedge fund?

As the term is used today, a hedge fund is a highly leveraged, aggressive, private investment fund. Hedge funds are only open to those who qualify by income or investment, and hedge fund regulation is minimal. They charge very high fees and performance bonuses compared to other types of investment vehicles. They have been criticised for their adverse effects on markets.

History of hedge funds

The first hedge fund was started in 1949 as a way to manage market volatility. What is hedging? The strict hedging definition is a strategy that uses long ans short positions to minimise the likelihood of large losses, and create an advantage for producing gains in a volatile market. Growth of hedge funds The explosion of hedge funds in the 1990s was brought about by the stock market boom and ensuring creation of wealth. Strategies became very aggressive, and far removed from the original definition. Hedge fund performance has been volatile, and this volatility can affect the market as a whole.

Hedge funds today

Though the financial problems of 2008 brought about some increase in regulation, hedge funds are still some of the least regulated investment vehicles. Their strategies have evolved to be very sophisticated and aggressive, and highly leveraged. Hedge fund news is hard to come by, because they are not required to divulge their activities. Who can invest? Hedge funds are restricted to accredited investors, such as those with a million dollars invested. This prohibits the ordinary investor from participating. Fees Most hedge funds work on a 2 and 20-basis. They charge 2% of the investment as a fee to pay managers, and 20% of profts as a performance bonus. This structure has been criticised because it encourages risky investments: the bonuses are paid when there are profits. However, there is no penalty when there are losses. Still, the best hedge funds have returns that justify the risk and the fees. Aggressive strategies Though the original intent of a hedge fund was to have long and short positions that balanced, today's hedge fund will make any investment it thinks will be lucrative, no matter how risky. Even when there're long and short positions, they often do not balance in the marketplace in any practical way. Leverage Hedge funds have access to leverage in terms of easy money loans, and use these to the maximum extent possible. The result is that when a large hedge fund incurs losses, it's forced to unwind its positions - sell the stocks it owns or buy back its shorts - in order to cover the losses. This can have an unsettling effect on the markets, and can create a spiral of continuing liquidations, losses, and uncertainty.