Why Invest In Hedge Funds?

Why Invest In Hedge Funds?

A hedge fund is a particular type of investment fund characterized by private management and a diverse range of market investment options. In the U.S., hedge funds are regulated by means of allowing only certain categories of qualified individuals to participate in the management of the funds. So why choose a hedge fund as part of your investment portfolio? One on the most common reasons is because of a hedge fund’s capacity to decrease risk while diversifying the market range of investment options, especially during periods of economic instability.

Risk Reduction

When it comes to the capacity of hedge funds to outperform classic investment funds, it is the reduction in the investment risk of hedge funds that are an attractive trait over more traditional funds. For instance, the managers of hedge funds utilize very sophisticated strategies of risk management to ensure maximum protection to the investor and the fund itself, often employing the most complex risk strategy systems found anywhere in the financial management landscape. To further help reduce risk, many hedge fund managers hire risk reduction officers whose specific job duty is to investigate and manage risk to hedge fund investments by use of sophisticated financial risk models. Furthermore, an assessment of due diligence is performed to further decrease risk. Thus, investors will be sure to investigate the chance of fraud or financial error possibly present in a hedge fund via; for instance, taking a close look at the hedge fund company’s organizational soundness and day-to-day operations, as well as whether or not the investment scheme is viable in the long term. So, if a hedge fund indeed proves to yield repeated returns, such behavior will reduce risk even further and increase the stability of an investment portfolio, even in the face of under-performance of classic investments within the same portfolio.

Greater Returns

Another attractive aspect of hedge funds, and reason to invest, is their level of increased returns and thus enhancement to the overall strength of a portfolio. The way a hedge fund can execute this is two fold. For one, a hedge fund can be used in what is called a “low-volatility” capacity, meaning that, existing alongside the more fixed return traditional investments, these low-volatility hedge funds can ensure bigger returns without any increase in instability. Secondly, and more interestingly, is that if you were to add a hedge fund with the ability to strategically yield a high return, your portfolio’s return will be greatly increased. Thus, for example, there are certain strategic hedge funds with incredibly high returns that operate by taking a specific investment direction that’s based upon that specific hedge fund’s strategic forecast of the price on commodities, monies, and stocks in the future. However, be aware that these hedge funds, while yielding high returns, can be incredibly unstable if improperly managed.

Business man and business woman discussing the hedge funds in an office.

Cautious Investments

Although including a hedge fund into your portfolio can yield impressive returns, one must tread carefully when doing so. As stated above, if improperly managed, even hedge funds with the lowest risk can still come back to haunt you. Thus, one thing to consider when deciding how to balance your portfolio through the allocation of hedge funds, is to take a good look at the pros and cons regarding risk versus return. So, even though it’s important to consider the weight of an investment, it’s just as important to take into account the density of the entire portfolio, with its correlated statuses of each investment in relation to each other. For instance, if you have a really dense portfolio, be sure that each investment status has a low correlation to every other investment. Another consideration when including hedge funds into your portfolio is the amount of exposure (net and gross) that exists in the portfolio as a whole. For example, with classic investments, such exposure will never change. But with hedge funds, most do fluctuate according the utilization of its own leverage, and so the gross and the net exposure will be determined by the long-term and short-term positions. Thus, overall, allocating a big percentage of hedge funds into your portfolio will surely affect the value of the portfolio, if, of course, such investments are wisely managed.

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