The Simplest Guide to Understand the Types of Hedge Funds

Since the first-ever hedge fund was established in 1949, the concept has now transformed into a full-fledged strategic investment model preferred by traders/investors for its high ROI.

Modern investors have several options to choose from when it comes to applying different strategies to different asset classes. Simply put, hedge funds are a different class of funds with high leverage. A hedge fund is a type of group of funds supervised by a fund manager who applies various strategies to bring a specific (highest possible) return on investment. There are various types of hedge funds that currently exist in the market and this guide, we shall discuss each one of them. Using hedge funds is another way to diversify one’s portfolio but a certain amount of risk is associated with all types of hedge funds.

hedge fundsThe goal of hedge funds

Positive returns despite the market’s overall condition are what each hedge fund operating in the market wants to achieve. It depends less on the market movement as its fund manager utilises a lot of strategies to ensure a better result. Hedge fund managers attempt to adapt to the market rather than allowing the market’s performance to dictate the results of the hedge funds they oversee.

Things to keep in mind before choosing a type of hedge fund:

  • As hedge funds present a greater possibility of rewards, therefore it also represents high risks of losing your capital.
  • Smart investors do not jump into hedge funds without proper understanding and information about the things they would have to face.
  • Selecting a hedge fund is not a standard process because there are no past returns or performances that investors can base their decisions upon.
  • The expertise of the fund manager and risk control features are some attributes to check before investing in hedge funds.
  • It is worth noting that hedge funds do not have a fixed definition from a legal perspective. The type of a hedge fund depends on the investment strategies applied by a fund manager.
  • Opposite to traditional funds whose primary concern is stocks and bonds, hedge funds are not limited. Through hedge funds, investors can invest in any available financial asset.

Common Types of Hedge Funds

As hedge funds differ primarily by the tactics used by a fund manager, the general hedge fund format includes the following:

Long/Short Funds

This format of hedge funds is considered to be the most popular among investors these days due to its straightforward approach. A long/short method would generally offer a mixed portfolio with at least 70% of managed funds invested in long positions while the other 30% of funds are invested in short positions. The strategy of holding both short and long positions allows this type of fund to outlast market volatility while maintaining profit growth over the short term.

Market Neutral Funds

As the name suggests, in the case of market neutral hedge funds, a fund manager applies market neutral investment plans to reach their profit goal. It works similar to the short/long strategy but the ratio of investment in long and short investment position is kept at 50/50 rather than 70/30. This rationale is specifically chosen to decrease the effects of market volatility over the hedge fund as well as maintaining a perfectly balanced position. Managing these types of hedge funds requires an extensive amount of time and effort. Market neutral hedge fund’s performance depends on the investments chosen by a fund manager rather than the market conditions.

Global Macro Funds

Some investors are determined to put their money where high risk and higher reward strategy is implemented. For such market participants, the global macro format is an appropriate choice as a hedge fund. This type of format usually includes options, derivatives, currencies, etc. as investments that do not influence the risk factor but its overall leverage. Due to high leverage, global macro fund managers may seem to be borrowing money for investing in various financial instruments to ensure significant success.

Utilising different types of hedge funds allows investors to make a profit while expending minimal effort. A bit of planning could help you to choose the right kind of hedge fund.