Hedge Funds. What are they?

Hedge funds have been around since the fifties but only grew in popularity in the 1960s. With big names like George Soros and Michael Steinhardt, fund management gained a high profile within the investment community and beyond. During this time, what didn't gain quite the exposure was what a hedge fund actually did.

Hedge funds are very similar to mutual funds except for fewer regulations and therefore can invest in a broad range of investments including shares, debt, commodities and so forth. Hedge funds have the freedom to seek to offset potential losses in the principal markets invested in by hedging their investments using a variety of methods, hence the name hedge funds. There are approximately 14 distinct investment strategies used by hedge funds, each offering different degrees of risk and return. A macro hedge fun, for example, invests in stock and bond markets and other investment opportunities, such as currencies, in hopes of profiting on significant shifts in such things as global interest rates and countries' economic policies.

Hedge funds are typically open only to a limited range of professional or wealthy investors. This provides them with an exemption in many jurisdictions from regulators governing shorting selling, derivative contracts, leverage, fee structures and the liquidity of interests in the fund.

A hedge fund will typically commit itself to a particular investment strategy, investment types and leverage levels via statements in its offering documentation, thereby giving investors some indication of the nature of the fund.

A persistent misconception in the general public is that all hedge funds act alike. Not true. On the one hand, you have "quants," short for quantitative investors that fine-tune software-driven investment strategies. On the other hand there are the hedge funds that invest through the market by getting under the skin of companies and reviewing their past and current performance and future earnings.

The other misconception is that all hedge funds are volatile. In reality, less than 5% of hedge funds are global macro funds. Most hedge funds use derivatives only for hedging or don't use derivatives at all, and many use no leverage.

Find more about hedge funds and their international regulations on Wikipedia