Hedging is a technique of portfolio management applied by some investment funds known as hedge funds The minimum investment capital required in this domain is significantly high, it runs into tens of thousands of dollars and in some cases hundreds of thousands.
Moreover, the area is not as regulated as with conventional mutual funds, and are mainly in the hands of institutional investors.
The reason hedge funds are regarded as risky is associated with the fact that beyond the “smoothing” of yield curves, they are known to play a part in speculative attacks with adverse economic impact. Top hedge funds are often closed, and thus are less liquid compared to other investments, and the minimum initial investment must be at least one million.
Hedge funds for the most part are unregulated and evaluating their risk is very difficult for an individual investor. Some funds have lower volatility than a market share of developed countries, and are also uncorrelated market shares.
It is also important to note that some high-performing funds can also be very opaque, hence the need for investors to be advised by a market specialist who has direct contact with fund managers
The hedge fund managers usually commit a large portion of their personal wealth in the funds they manage, and their salaries rely primarily on the fund’s performance. Even though, these funds are frequently closed and limited in size, the potential gain for the fund managers can become considerable because they are correlated, in relation to the size of the fund. That is, a portion of the funds contributed by an investor plus 20% performance fees.
To construct a diversified portfolio, fund managers use various strategies. And to fight against the lack of transparency and low liquidity, the banking industry developed strategies around the idea of managed accounts. Banks are therefore in a position to replicate hedge fund strategies while providing access to a larger number of investor tools.
Hedge funds generally offer low liquidity to their subscribers, and an investment has to wait between one to three months prior to obtaining a warrant and then between two to twelve months to pull out of the fund. This lack of liquidity is not desirable to investors looking for investment instruments that are more liquid. However, the emergence of managed accounts tends to resolve problems related to liquidity and transparency.
The substantial growth of investments in hedge funds is fuelled by the fact that many managers are seeking the same investment opportunities with more money than in previous years.