What is Hedge Funds in Mutual Fund?

Hedge Fund Meaning

A hedge fund is a type of investment company that makes investments in various financial assets with the intention of making a high return using a pooled amount of money from authorised individuals or institutional investors. The use of leverage and derivatives is one of the active fund management techniques employed by hedge funds. Hedge funds can be more expensive than conventional investment funds because they sometimes impose a performance fee in addition to a management fee.

Who should invest in hedge funds

Investors must fulfil specific requirements in order to be qualified to invest in hedge funds, which are normally only accessible to accredited investors. High net worth or income are two of these requirements. Investors are advised to conduct due diligence before investing in hedge funds, including looking at the fund’s investment philosophy, past success, and costs.

Common Hedge Fund Strategies

Hedge funds come in a variety of forms, including equities long/short, event-driven, and global macro. Each sort of hedge fund has a unique risk profile and investing approach. Equity long/short funds, for instance, invest in both long and short stock positions with the goal of making money regardless of the state of the market. On the other hand, event-driven funds invest in the securities of businesses that are going through important corporate events including mergers and acquisitions, insolvencies, and spin-offs. In order to profit from macroeconomic trends, global macro funds invest across a range of asset classes, such as equities, bonds, currencies, and commodities.

How are hedge mutual funds taxed

Profits and losses from hedge fund companies are usually distributed to investors as limited partnerships. This implies that regardless of whether the money is delivered to investors or reinvested in the fund, they must pay taxes on their portion of the fund’s revenue. Moreover, complicated investing methods that hedge funds may employ including derivatives and short sells may have an effect on how earnings and losses are taxed. Moreover, certain tax regulations that restrict the ability to offset profits and losses, such as the “wash sale” rule and the “straddle” rule, may apply to hedge funds.

Types of Hedge Funds

Hedge funds can be categorised into multiple different types based on their theme and investment objective. Let’s take a look at some of the most common types of hedge funds. 

• Equity Hedge Funds

As the name implies, equity hedge funds primarily invest in equities or stocks. Fund managers often employ a mix of different strategies ranging from long or short equity (buying undervalued stocks and selling overvalued ones) to market-neutral strategies.

• Global Macro Hedge Funds

Global macro funds take a macroeconomic approach, making investments based on global economic trends. Fund managers often take positions in various global asset classes such as currencies, commodities and interest rate derivatives. 

• Relative Value Hedge Funds

Relative value funds aim to take advantage of pricing discrepancies between related financial instruments like equity shares and equity derivatives or bonds and interest rate swaps. 

• Activist Hedge Funds

Activist hedge funds take an activist approach to their investments. Unlike traditional hedge funds that primarily focus on generating returns through various investment strategies, activist hedge funds aim to influence the management and policies of the companies in which they invest.

Common Hedge Fund Strategies

Hedge funds often employ multiple strategies to generate returns from their investments. Some of the most common strategies include the following. 

• Event-Driven Strategies

Event-driven strategies leverage specific events that might affect a company’s stock price significantly. The events can include mergers and acquisitions, bankruptcies, restructurings or other corporate actions.

• Long/Short Equity Strategies

Long/short strategies take both long (buy) and short (sell) positions in stocks. The primary goal of such strategies is to profit from both rising and falling stock prices.

• Global Macro Strategies

These strategies make bets on macroeconomic trends and events. They may involve trading in currencies, commodities, interest rates and equity indices based on their analysis of global economic conditions.

• Arbitrage Strategies

Arbitrage strategies involve exploiting price differentials between related assets. Some examples include merger arbitrage, convertible arbitrage and statistical arbitrage.

• Market-Neutral Strategies

Market-neutral strategies aim to generate returns while minimising exposure to overall market volatility. These funds typically balance both long and short positions to hedge against market risk.

These are just some of the many strategies that hedge funds use. Long-term value investing, managed futures, credit strategies and distressed debt are some of the other strategies that these funds employ to generate returns from the market. 

Hedge funds vs. mutual funds

Hedge funds and mutual funds are both investment vehicles, but they have some key differences. Only qualified investors who fulfil specified requirements for net worth and income are typically permitted to invest in hedge funds. Also, they are renowned for their active management techniques, which may entail leveraging and employing derivatives to produce large profits. Hedge funds frequently charge a management fee in addition to a performance fee, which is deducted from the fund’s earnings. Hedge funds can be riskier investments since they are only accessible to a small number of investors and are subject to less regulation than mutual funds. Contrarily, mutual funds are offered to the general public and are subject to SEBI regulations. They may invest in a larger range of assets, such as stocks, bonds, and other securities, and are often less actively managed than hedge funds. Most mutual funds simply charge a management fee, which is a portion of the assets they are responsible for managing. Mutual funds are typically seen as less dangerous than hedge funds since they are accessible to a larger variety of investors and are subject to more regulation. The liquidity of hedge funds and mutual funds is another important distinction. In contrast to hedge funds, mutual funds are often more liquid, allowing investors to purchase and sell shares at the fund’s net asset value (NAV) on a daily basis. In contrast, hedge funds could impose extended lock-up times during which investors cannot withdraw their money as well as limitations on when and how they might do so. Also Read Mutual Funds Vs Hedge Funds

Things to keep in mind before investing in hedge mutual funds

Here are some things to keep in mind before investing in hedge funds:

Accredited Investor Status:

Only accredited investors, which are people or organisations that satisfy specified requirements for net worth and income, are normally permitted to invest in hedge funds. When considering hedge funds as an investment option, be sure you are eligible to invest in them.

Investment Strategy:

Hedge funds employ a range of investment methods, so it’s crucial to comprehend the one used by the fund you’re thinking about investing in. Make sure you are aware of the strategy’s risks and that it fits with your investment objectives and risk tolerance.

Historical Performance:

Check out the hedge fund’s prior performance. Although previous performance cannot predict future outcomes, it can give a hint as to the fund manager’s capacity to produce returns.

Fees:

Hedge funds often charge both a management fee and a performance fee, which can be larger than the costs imposed by mutual funds. Be sure you are aware of the costs related to the hedge fund you are thinking about, as well as how they will affect your returns.

Liquidity:

As hedge funds often have less liquidity than mutual funds, it may be more challenging to buy and sell shares in a hedge fund. Take into account if you can afford to have your money locked up in the fund for a long time.

Diversification:

Consider including hedge funds in your portfolio of varied investments. You should think about investing in a variety of hedge funds with various investment strategies rather than putting all of your money in one single hedge fund.

Conclusion

Hedge funds are a great way to invest and expand your capital. However, there are other avenues for long term investment as well such as mutual funds, stocks and debt instruments. Open demat account with Angel One to take advantage of the entire spectrum of investment options available.

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