Hedge funds, also known as Private Investment Companies (PICs), are private investment vehicles used for trading in securities and derivatives. They are regulated by the United States Securities and Exchange Commission (SEC) and most of the countries.
What are hedge funds?
Hedge funds are private investment companies that specialize in trading in financial assets. In simple words, they are basically investment vehicles that invest in securities, commodities, and other assets that are not traded on public markets.
They were first introduced in the late 1970s and the first hedge fund was launched in 1972 by Julian Robertson of Tiger Management.
Hedge funds are considered to be a risky investment because the market conditions are unpredictable.
Hedge funds are categorized as either open-ended or closed-ended.
Open-ended hedge funds include those where the investor can invest in more shares at a later stage. The number of shares is predetermined and the amount of capital can vary.
On the other hand, closed-ended funds have a fixed number of shares and the amount of capital is predetermined.
There are two main reasons why people invest in hedge funds. One is that it is an alternative investment, and the second is that it offers a higher return on investment.
How hedge funds work?
Hedge funds use a variety of strategies to make money. Some of the most commonly used strategies include:
Managed account: This is a managed fund that is set up for an individual.
Closed-end funds: These are funds that are limited to a particular group of investors.
Mutual funds: These are funds that are open to all the investors.
How much does a hedge fund cost?
It is true that investing in hedge funds is a risky investment, but it is also true that investing in hedge funds can provide high returns.
Hedge funds are available in all the major markets, including the United States, the United Kingdom, and Japan.
The annual fees charged by hedge funds vary depending on the investment options and the market. For example, if you invest in an index fund, you will have to pay a small amount as an annual fee.
However, if you invest in a convertible bond that pays a dividend, then you will have to pay a higher annual fee.
Hedge funds are available in a wide range of styles. However, the most common styles are as follows:
Long only: This is a fund that invests in assets that have a higher risk and offer a higher return.
Short only: This is a fund that invests in assets that have a lower risk and offer a lower return.
All-weather: This is a fund that invests in assets that have a high level of liquidity and are not affected by economic cycles.
Other styles include:
Value: This is a fund that invests in a portfolio of stocks with a low price-earnings ratio.
Momentum: This is a fund that invests in stocks that have had a strong performance in the past.
Growth: This is a fund that invests in companies with high growth potential.
The average hedge fund is the most expensive investment vehicle to own, costing around $50,000 per year. What’s surprising is that the fees continue to compound over time. Let’s take a closer look at how fees compound over time.
The average annual fee for a hedge fund is around 1%. So, if you had a $100,000 investment in a hedge fund, you would pay around $1,000 each year.
As we all know, interest compounds over time. If you deposit $10,000 into a bank account, you earn interest of 2% per year. So, the total value of your account is $20,000 after five years.
Hedge Fund Fees
Now, let’s apply the same concept to a hedge fund. The average annual fee is 1%, so the total value of your hedge fund is $100,000 after five years.
If the average annual return is 15%, then your account value will be $150,000 after five years. So, your $100,000 is now worth $150,000. Your annual hedge fund fee has compounded to over $4,000.
After five years, you’ll have $150,000 invested in a hedge fund. To calculate your final total, you’ll subtract your initial investment ($100,000) from your final total ($150,000), giving you a final value of $50,000.
So, if you were to invest in a hedge fund, the first year would cost you $1,000. After five years, you’ll be left with a $50,000 portfolio. However, your annual fees have now compounded to more than $4,000.
What’s your opinion? Do you agree with the hedge funds fees? Please share your thoughts in the comments section below.