What Is Hedge Fund Or Hedge Funds?

Hedge funds are private investment funds and investors need to pay performance fee on them. Often a hedge fund or hedge funds are open to a limited number of customers only. Though the funds do not essentially enclose their investments against odds in the market, but they are called so with the purpose of keeping them separate from other regulated retail investment funds like pension funds or mutual funds to name few.

Generally, hedge funds are structured as limited partnerships, and thus allowing the investment can be done on behalf of organizations as well as individuals of hi-net value. However, the common aim is to produce returns which must not be related to the returns in the financial markets at broader level.

Hedge funds unlike mutual funds, normally take long and short positions in assets to reduce the portfolio risk which could occur from broad market movements. Long positions can be taken by these funds in certain stocks and short positions in others so that their portfolio beta remains close to zero. A portfolio beta close to zero remains relatively unaffected because of the broad market movement. Such a portfolio will only change if the movement of stocks is more than the broad market.

Hedge funds' activities are limited under the terms of the contracts governing a particular fund. They follow certain complex investment strategies, such as investing in long or short assets and entering into various other contracts.

Performance Fee: Most often, a hedge fund manager gets a management as well as a performance fee. Like all other investment funds, the management fee is calculated as a percentage of assets under management. Performance fees constitute an important aspect of hedge funds. A performance fee provides a hedge fund manager with a part of positive returns. The performance fee is calculated as a percentage of the fund's profits, including both profits on the paper as well as actual trading profits. There are performance fees because on making money, investors often pay managers with their own willingness. It is really profitable for the managers who perform their functions properly.

Managers generally believe that a performance fee aids to align their interests with those of the investor in a better way as compared to a flat fee because it needs to be paid even in the poor performance. However, performance fees is criticized by many people because managers get greedy and sometimes they end up in taking excessive risk, as opposed to high long-term returns. To keep hole over these problems, fees are often restricted by high water marks and sometimes it is done by applying hurdle rates.

High Water Mark: It implies that manager is not entitled to receive any incentive fees until and unless the previously achieved highest net value is crossed by the fund value. This measure links the manager's interests more closely with the interests of the investors and thus, the incentive for managers to enter into risky trades is reduced.

Hurdle Rates: It means that performance fee cannot be charged on the fund until and unless the annualized performance of the fund reaches beyond a benchmark rate. This way the performance fee is connected to the ability of the manager to do better than the investor by putting the money in a bank account.