What Are Hedge Funds?

Risk is the name of game for hedge funds, which is contrary to its given name.  Although they are high risk, there are also big payoffs for their investors if speculators accurately assess the market.

Video: Hedge Funds - Funds of Funds

Hedge funds consist of a pool of capital unregulated in the U.S. if no more than 100 investors participate.  A general manager oversees the funds.  Large bets are made on global market movements with the goal of achieving quick capital gain.  These are very aggressive funds, many of which are bought based on speculation.  Hedge funds are purchased with money from investors, along with money borrowed by the hedge fund for the purpose of investing.

By virtue of its name, hedge funds attempt to hedge, or reduce risk to, their investments, most notably, by short selling.  Hedge funds are dominant in certain specialty markets, like trading in distressed debt and derivatives with high-yield ratings. 

In layman’s terms, that means that hedge funds trade in companies that are in distress – on the brink of bankruptcy or in bankruptcy.  Companies sell their assets at a severely reduced cost to hedge funds who quickly turn the assets for capital profit. 

Derivatives are more dangerous commodities in which to invest.  They are securities whereby their values are based on the value of another security.  A good example of this might be that farmers use futures contracts to lock in a specific price for their grain at harvest.  Speculators of hedge funds use the farmer’s futures contracts to leverage bets on the cost of agricultural commodities.  These bets can either pay off big or go bust.

Video: H-E-D-G-E (By Merle Hazard)

Unlike hedge funds, most other funds are structured largely in attempts to mitigate loss, but there are other differences that set hedge funds apart from most other funds.  Hedge funds are fairly unique in that they:

• Are not regulated by the Securities and Exchange Commission (SEC); although, they must adhere to the same standards of ethics in regards to fraud.
• Invest in largely liquid assets and derivatives; although, they also invest in mortgage backed securities and a variety of other funds.
• Are not required to price and be made liquid daily, which means that neither the public nor investors are fully informed of their value, or lack thereof.
• Have a general manager who oversees the hedge funds and is paid relative to the success of the funds.
• Are not required to disclose their dealings, which make it very difficult for investors to have visibility to the status of the funds or develop strategies relative to the hedge fund investments.
• Report unrealized gains to their investors and the public based on the projected value of the investments and assets.  In turn, they could easily inflate profits.
• Require that you be an accredited investor in order to invest in a hedge fund unless you are an employee.   An accredited investor is someone who has a net worth of $1 million U.S.  or more.  You can also be considered an accredited investor if your income was $200,000 or more for each of the past two years – $300,000 for a joint account with spouse,  AND you expect to make the same income this year.

In recent news you’ve probably seen Bernie Madoff’s dirty laundry being paraded throughout different programs on TV.  According to allegations, Bernie “made-off” with billions.  His is a classic example of what happens when hedge funds go wrong.

Hedge Fund Resources

If you’re not scared off by now and are an accredited investor, you may actually be a good candidate for investing in a hedge fund.  There are innumerous companies that sell them.  Here are some names of hedge fund companies, along with their respective hedge funds.

Harbert Management Company
Harbinger’s Capital Partner’s Fund I
Harbinger Capital Partners Special Situations Fund

A I M Advisors, Inc.
AIM Libra Fund

Driehaus Capital Management
Driehaus Small Cap Recovery Growth

Lee Capital Management
RJL Partners Off-Shore Fund

Libra Advisors
Libra Fund LP

Wasatch Advisors
Wasatch Micro-Cap

Caldwell & Orkin
C & O Investment Partnership, L.P.

Paradigm Global Investors, LLC
Paradigm Equities, Ltd.

Twin Securities, L.P.
Twin Securities, L.P.

Private Capital Management
Value Equity

Needham & Co.
Needham Emerging Growth Partners, LP

Veredus Asset Management LLC
Veredus Partners, LP

Pinnacle Associates Ltd.
Small/Mid Cap Value Equity