Investment Types - Hedge Funds
Hedge Funds
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Hedge Funds

Hedge funds originated on Wall Street in the 1940s and were initially aimed at very wealthy individuals. For decades, they were only used by professional or institutional investors and there were few outside of America.

But thanks to changes in the rules which mean investment funds can use the kinds of financial instrument open before only to institutions, there are now many funds on offer to ordinary investors. Any fund calling itself an ‘absolute return fund’ will, for example, use the kind of financial bets common in hedge funds.

Hedge funds invest in many different asset classes and sectors but they also employ a wide range of complex strategies to 'hedge' their risk against market volatility. The success of the hedge fund ultimately comes down to how skilful the fund manager is at limiting exposure to market falls. This style of aggressive and highly active management should, in theory, keep returns consistent and comparatively high. 

These strategies will include buying financial bets to cover moves both up and down in share prices. Often it will mean taking positions on share price movements when the fund may not even own the underlying stock by using derivatives. These are essentially bets on the future direction of an underlying asset such as a share, currency, or even a whole financial market. Some hedge fund managers use these exclusively rather than buying the underlying asset directly, possibly because they can build up a larger investment base than they could afford directly. 

Investors can still lose money or get mediocre returns in hedge funds, as the strategies employed by hedge fund managers are complex and highly risky. Ordinary investors also need to consider how much they will pay in fees for these highly managed funds, how they compare to fees on other funds that may perform just as well and whether higher fees could end up wiping out your returns if things go awry. In addition, some have performance-related fees which mean that the charges go up if the fund performs particularly well.

You can invest directly in an individual hedge fund, but another option is to buy into a managed 'fund of funds', which in turn invests in certain hedge funds deemed to be performing well or to have future potential.

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