What are Hedge funds And How it Works
Hedge funds are an offshore investment fund, typically formed as a private limited partnership, which engages in speculation using credit or borrowed capital. Of recent, they have been growing and become much larger in the market . There are hundreds and thousands of hedge funds listed in the market. Hedge funds tend to be secretive; they tend to be privately owned and privately managed and they also are normally funded by private investors and investment bankers who claim to have a “strategy” on how to use these funds.
Here is how a simple hedge fund works in Lehman terms – Rob is watching a soccer match and finds that there is a 6-7 second delay from real time. So he starts a live radio show on his radio which streams the audio of the matches in real time and bets on the goal before it is scored. Rob knew the goal was going to be scored and he wins money on the bet since he knew the goal was being scored. This is the simplest example of how hedge fund investors operate on the market. If everyone knew about this, it would be worked around and no one could follow this, hence Rob kept it to himself as a private strategy. Hedge funds work in the exact same way, because if the strategies were publicized, everyone would do it and make profits in turn.
Unlike mutual funds and other funds, hedge funds tend to lock in their investors. Hedge funds are unregulated funds. This is not the same as illegal, unregulated only means that monetary authorities and legal persona do not regulate these funds. This gives hedge funds an advantage that allows them to do things that standard regular funds cannot, such as playing derivatives to a greater extent for example. Standard derivative rules do not apply to hedge funds, they can be manipulated in multiple ways.
Hedge funds are able to promise absolute returns over cash and money market deposits no matter the condition of the market. Hedge funds tend to have high fees as well. There is a structure known as the “two and twenty” structure. This is where the hedge fund manager takes out two percent as a standard annual management fee. If the hedge fund makes a profit, twenty percent of these profits go into the pockets of the hedge fund manager. Hedge fund returns are usually heavy and profitable and this is why investing hedge fund managers charge a standard percentage of profits which is the two and twenty structure.
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