It is not uncommon to hear about hedge funds in the general media.
As the name implies, it is a fund involved in a hedging strategy.
We are talking about hedge funds because they are sometimes responsible for the volatility of the stock markets and because it is not always clear to the man of the street what they are, how they are composed and how they work.
Every hedge fund has rules that absolutely must be followed by the fund creator.
Regulations changes from country to country, such as the percentage of accredited investors or the type of investments that can be made. In addition, each fund has internal regulations to better manage its existence.
Generally, hedge funds in the Western world are allowed to purchase all financial assets recognized by their regulatory entities. But I advise you to specifically check the regulations of your country of residence in order not to make mistakes, all before investing.
It happens very often that the creator and manager invests a large chunk of their money in hedge funds. We are talking about a few million dollars, so as to push other investors to trust him given the particularly high personal figure involved.
After that there will most likely be a minimum amount to invest in the fund, which could be 500k or $ 1 million. in this way he will have a sufficient amount of liquid to invest and will have to deal with a low number of people, more easily manageable.
One of the rules that could be decided by the manager is to freeze the funds for a certain period of time which could be one or two years. In this way the manager will be able to invest liquidity in instruments that are also very risky without having problems of lack of funds due to an investor who wants to exit the fund.
Again for this issue, the manager could add to his rules a limited time window for the repayment of the capital added to the fund, such as once or twice a year.
The manager will have a large variety of assets to invest in, and to hedge the risk of these investments he will have hedging techniques by investing in derivatives and other instruments.
Obviously the manager can be both long and short on chosen assets, with a long investment and another short to cover the risk of the long.
the manager’s remuneration will be a percentage, and may be a small percentage of the initial paid with a larger percentage of the gain achieved (in the order of 20, 30 or 40 percent)
Now, one of the riskiest moves that the manager can make is to take advantage of financial leverage, that is to ask for a loan from a bank. Let’s assume a 5 to 1 leverage, with the manager having 10 million dollars under management and receiving 50 million from a bank, for a total invested liquidity of 60 million.
Both the financial leverage and the limited repayment window are the topics that can worry the most during a possible crisis or collapse of the markets
in fact, many investors may prefer to remain liquid and not invested in the market, so they may request redemption.
In this case, the fund should liquidate its assets very quickly.
This rapid liquidation would lead the market price to fall even further, especially if it is not just a fund that has to liquidate but a large number of funds.
You understand that the figures involved are very high and the speed of sale must be in line with the requests of the investors. The exit from the market, if done in a moment of panic, could also be very painful for the customer portfolio and even more so for the manager with the possible cancellation of the fund.