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Hedge Funds: Definition and viability

Money doesn’t grow on trees. Making money is all about investing. In 1949, Alfred W. Jones set up the first hedge fund. He bought assets with the price he expected to rise and was selling assets with the price he expected to drop.

It is considered that the term hedge fund is derived from the phrase “to hedge one’s bets.” The idea behind this strategy is to gain profit in spite of the indexes’ movements on the market. Hedge fund is not an official term. It refers today to privately owned funds which have an unregulated pool of capital. Unlike mutual funds, hedge funds are not required to be registered with the SEC (Securities and Exchange Commission). These funds combine short sales and leverage techniques to maximize profit.

In the mid 1950s, other funds were established that started to practice short sales, but they were not focused on hedging market risks as hedge funds were.

The growth of hedge funds on U.S. markets is in progress. Usually, hedge funds are open only for wealthy investors. Hedge funds are not called as such because they use hedging techniques, but instead it’s due to their status as a private and unregistered investment pool. The managers of these funds perform speculative trading on falling and rising assets. Investors of hedge funds are charged management fees that depend on the amount invested and also the performance fee that is determined by the profits.

Contemporary hedge funds use the following strategies: arbitrage, highly undervalued securities, purchase or sale, stock options and bond trading. Arbitrage occurs when a hedge fund is buying securities on the market while selling other securities simultaneously. The profit is gained from the price difference. Hedge funds don’t possess the corporate model of many other funds. Instead, hedge funds hold the status of partnership.

Both mutual funds and hedge funds gain money from investors and investment occurs on a collective basis. The difference between them lies in regulations. They rely on Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940. But it may be changed, as the SEC has been considering changes for hedge fund rules. Now, a voluntary registration is suggested for funds with assets totaling more than $25 million.

Investing in hedge funds can be more profitable than investing in other funds. Based on historical data, hedge funds outperform on a long term basis, bringing a long term profit. A diversified portfolio of hedge funds may return superior gains with a lower risk compared to traditional equity portfolios.

London is a leading center for hedge fund management, while hedge funds themselves are often established in offshore centers. Major offshore areas where hedge funds have been established are the Cayman Islands, British Virgin Islands, Bermuda and some others. They have to comply with the requirements of the offshore centers, but the requirements are often rather nonrestrictive for hedge funds there. For example, taxes are usually lower for the offshore areas than in the U.S. and Europe.

The information supplied in this article is not to be considered as medical advice and is for educational purposes only.

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