Hedge fund explained and simplified
Hedge means to protect money and fund is a pool of money. Hedge fund takes investor’s money so they have a pool of money and invest that pool of money with the intent to generate profit.
You may ask your self , this sound like assets management or mutual funds.
Well kind off.
Hedge funds are not as regulated by the Secretary of Treasury (SEC) as assets management or mutual funds are, so they can take more risk by using leverage.
Example:
A hedge fund can borrow money for simplicity lets say they borrow $100 at 3% interest.
So they now have $100 cash and owe $103.
They take that $100 cash and invest it into some type of investment that could generate 10%. if it does then they now have $110
So, $110 – $103 = $7 dollars profit.
Now, because Hedge funds are not as regulated by the SEC they can invest in all kind of investment that can generate high profits such as 20% profit, 30% profits and so on. Not only that but they can invest in things that can 1x the initial investment or they can 10x the initial investment and so on.
Moreover, hedge funds get paid a percentage of the profit that is generated that’s why they are well incentivize to bring bigger profits.
From the profits that is generated they can ask for 10% or 20% or more.
Imagine if they are managing $10,000,000 and they generate 10% profit. That’s $1,000,000 profit. But from that one million profit they ask to get pay 20%, so the hedge fund manager made $200,000.
They can ask for this kind of paid because of the high profits they are able to generate. They able to generate this high level of profit because once again they are not as regulated by the SEC.
So they can do speculative investment, the can do short selling and all type of investment that we may not be aware off since they are not as regulated so they may not have to report to the SEC.
High Risk bring High reward or High loses
High risk bring high reward but also it may bring High loses. The down side of investing with a hedge fund is that they can also bring high loses.
Once again they can take these high risk because they are not as regulated by the SEC.