A hedge fund is basically a fancy name for an investment partnership. It’s the marriage of a fund manager, which can often be known as the general partner, and the investors in the hedge fund, sometimes known as the limited partners.
The limited partners contribute the money and the general partner manages it according to the fund’s strategy. A hedge fund’s purpose is to maximize investor returns and eliminate risk while performing wealth management, hence the word “hedge.” If these objectives sound a lot like the objectives of mutual funds, they are, but that is basically where the similarities end.
The name “hedge fund” came into being because the aim of these vehicles was to make money regardless of whether the real estate investment market climbed higher or declined. This was made possible because the managers could “hedge” themselves by going long or short stocks (shorting is a way to make money when a stock drops).
- Only open to “accredited” or qualified investors: Investors in hedge funds have to meet certain net worth requirements to invest in them – net worth exceeding $1 million excluding their primary residence.
- Wider investment latitude: A hedge fund’s investment universe is only limited by its mandate. A hedge fund can basically invest in anything – land, real estate, stocks, derivatives, currencies. Mutual funds, by contrast, have to basically stick to stocks or bonds.
- Often employ leverage: Hedge funds will often use borrowed money to amplify their returns. As we saw during the financial crisis of 2008, leverage can also wipe out hedge funds.
- Fee structure: Instead of charging an expense ratio only, hedge funds charge both an expense ratio and a performance fee. The common fee structure is known as “Two and Twenty” – a 2% asset management fee and then a 20% cut of any gains generated.
There are more specific characteristics that define a hedge fund, but basically because they are private investment vehicles that only allow wealthy individuals to invest, hedge funds can pretty much do what they want as long as they disclose the strategy upfront to investors. This wide latitude may sound very risky, and at times it can be. Some of the most spectacular financial blow-ups have involved hedge funds. That said, this flexibility afforded to hedge funds has led to some of the most talented money managers producing some amazing long-term returns.
By most estimates, thousands of hedge funds are operating today, collectively managing over $1 trillion making for many investment opportunities. Hedge funds can pursue a varying degree of strategies including macro, equity, relative value, distressed securities and activism. A macro hedge fund invests in stocks, bonds and currencies in hopes of profiting from changes in macroeconomic variables such as global interest rates and countries’ economic policies. An equity hedge fund may be global or country specific, investing in attractive stocks while hedging against downturns in equity markets by shorting overvalued stocks or stock indices. A relative-value hedge fund takes advantage of price or spread inefficiencies. Other hedge fund strategies include aggressive growth, income, emerging markets, value and short selling.
Another popular strategy is the “fund of funds” approach in which a hedge fund mixes and matches other hedge funds and other pooled investment vehicles. This blending of different strategies and asset classes aims to provide a more stable long-term investment return than any of the individual funds. Returns, risk and volatility can be controlled by the mix of underlying strategies and funds.
To learn more about hedge funds for land and real estate investments, contact an expert member of the Asset Quest team at (239) 541-8448.