What Is A Hedge Fund? – FinancialNewsPages.com

What Is A Hedge Fund?

High-frequency trading

HFT is a method of trading stocks using computer algorithms. These algorithms make trades based on the smallest discrepancies between price and time. HFT firms use this technique to make a profit in the markets by exploiting market inefficiencies. A typical example is when a stock spikes in price, and HFT algorithms are able to take advantage of that. This allows the trader to profit by taking a position early and trading out before the price spike fizzles.

Historically, there have been a number of firms that have specialized in HFT. Some have spent years building their technology, while others are relatively new. Moreover, the firms that have been in the business for a long time already have a lot of experience in the field.

Quantitative arbitrage

Hedge funds use quantitative arbitrage strategies to improve returns while minimizing risk. The goal of a hedge fund is to generate a positive annual return with limited swings in value. To accomplish this, these funds use the latest in financial science and technology, including massive mathematical processing, risk measurement techniques, and leverage. Many of these funds actively trade in futures and corporate equities.

A hedge fund may use a portfolio strategy that involves holding long subordinate bonds and short senior bonds, as well as long equity and short credit default swaps. The downside of this strategy is that stocks carry higher risks than bonds, and bonds have a prior claim on a company’s liquidation. However, the upside of this strategy is that it allows fund managers to take advantage of opportunities in interest rate securities.

General partners

General partners of hedge funds earn a performance fee in exchange for a percentage of the fund’s earnings. This incentive fee is generally around 20 percent of the fund’s net asset value. However, they are only paid when the fund achieves its “high-water mark,” which represents the highest amount of the initial capital contribution and net asset value.

Carry-interest tax breaks can also help general partners avoid paying taxes on the income received. Under this tax break, the general partner receives a 20 percent portion of the income from the partnership, which is taxed at a lower rate than in an ordinary portfolio. In addition, he or she also benefits from lower tax rates for 60/40 and long-term capital gains. These tax breaks are especially useful for investors looking to avoid paying investment expenses, which are often disallowed if they have an AMT tax burden.

Investment strategies

There are many different investment strategies used by hedge funds. Some of these strategies are event-driven and some are not. Event-driven strategies take advantage of a situation in which a risk or opportunity is related to a certain event, such as a corporate transaction. These strategies may include purchasing debt from companies that are facing bankruptcy or distress. Other strategies focus on relative value arbitrage, which seeks to exploit price discrepancies.

Another common hedge fund strategy is fixed-income arbitrage. This strategy seeks to exploit the discrepancy in value between securities in the same industry. For instance, a short-selling hedge fund might buy Coke and sell Pepsi, and make a profit if the stocks fall in value. In order to take advantage of this strategy, managers make leveraged bets on the shape of the yield curve. For instance, a manager who expects long rates to rise would sell short long-dated bonds and buy short-dated stocks.

Investors

Investing in hedge funds requires some knowledge of the industry and a high level of risk. They typically require the investor to pay 2% of their assets and 20% of the profits from the fund. Nonetheless, the returns can be substantial and they are also a good way to diversify an investment portfolio. However, most hedge funds don’t disclose how they get their returns, which can lead to Ponzi schemes.

Hedge funds are often regulated and must meet certain qualifications before they can accept new investors. These requirements may be more stringent if the investor is low-net-worth or has little or no wealth. Generally, hedge fund investors must have a minimum of $1 million in net worth and $750,000 in assets under management in order to be eligible for participation in the fund.

About the Author: Michael Scott

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