Editorials

by Rajen Kumar

No Escaping Social Media

Running a magazine concentrating on issues of small and medium enterprises and managing with limited resources is a like living life on the edge. In this rush of meeting deadlines,...

Special Reports

Apr 2012

EMRC, Brussels Associates with SME WORLD as its New Media Partner

EMRC has promoted business partnerships with the developing world and has organised dozens of business forums in key decision-making cities, such as Amsterdam, Rome,...

Knowledge Kit

Hedge fund, Investment banking, Credit Union, Microcredit – SME Knowledge Kit

Nov 2009

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Hedge fund

A hedge fund is an investment fund open to a limited range of investors that is permitted by regulators to undertake a wider range of investment and trading activities than other investment funds, and that, in general, pays a performance fee to its investment manager. Every hedge fund has its own investment strategy that determines the type of investments and the methods of investment it undertakes. Hedge funds, as a class, invest in a broad range of investments including shares, debt and commodities.

As the name implies, hedge funds often seek to hedge some of the risks inherent in their investments using a variety of methods, most notably short selling and derivatives. However, the term "hedge fund" has also come to be applied to certain funds that do not hedge their investments, and in particular to funds using short selling and other "hedging" methods to increase rather than reduce risk, with the expectation of increasing the return on their investment.

Hedge funds are typically open only to a limited range of professional or wealthy investors. This provides them with an exemption in many jurisdictions from regulations governing short selling, derivatives, leverage, fee structures and the liquidity of interests in the fund. This, along with the performance fee and the fund's open-ended structure, differentiates a hedge fund from an ordinary investment fund.

The net asset value of a hedge fund can run into many billions of dollars, and the gross assets of the fund will usually be higher still due to leverage. Hedge funds dominate certain specialty markets such as trading within derivatives with high-yield ratings and distressed debt.

History

Sociologist, author, and financial journalist Alfred W. Jones is credited with the creation of the first hedge fund in 1949. Jones believed that price movements of an individual asset could be seen as having a component due to the overall market and a component due to the performance of the asset itself. To neutralize the effect of overall market movement, he balanced his portfolio by buying assets whose price he expected to be stronger than the market and selling short assets he expected to be weaker than the market. He saw that price movements due to the overall market would be cancelled out, because, if the overall market rose, the loss on shorted assets would be cancelled by the additional gain on assets bought and vice-versa. Because the effect is to 'hedge' that part of the risk due to overall market movements, this became known as a hedge fund.

Investment banking

An investment bank is a financial institution that raises capital, trades in securities and manages corporate mergers and acquisitions. Investment banks profit from companies and governments by raising money through issuing and selling securities in capital markets (both equity, debt) and insuring bonds (e.g. selling credit default swaps), as well as providing advice on transactions such as mergers and acquisitions. A majority of investment banks offer strategic advisory services for mergers, acquisitions, divestiture or other financial services for clients, such as the trading of derivatives, fixed income, foreign exchange, commodity, and equity securities.

In terms of regulatory qualification, to perform these services in the United States, an adviser must be a licensed broker-dealer, and is subject to Securities & Exchange Commission (SEC) (FINRA) regulation[1]. Until 1999, the United States maintained a separation between investment banking and commercial banks. Other industrialized countries (including G7 countries) have not maintained this separation historically.

Trading securities for cash or securities (i.e., facilitating transactions, market-making), or the promotion of securities (i.e., underwriting, research, etc.) was referred to as the "sell side".

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