What Is a Hedge Fund?

What is a Hedge Fund?

A Hedge Fund is a private investment vehicle that is less regulated than traditional investment companies. The name comes from the funds' traditional role as "hedges" against downturns in more conventional investments. Hedge funds have historically taken investment positions that are relatively uncorrelated with broader financial markets or that may be in opposition to broader markets. In more recent years, the term has been expanded to cover funds that employ very complex investment strategies. Once relatively obscure and, by federal statute, reserved for very wealthy investors, hedge funds today manage nearly $1.5 trillion in assets for investors that include pension funds and university endowments.

Academics, industry professionals, and regulatory authorities overwhelmingly agree that hedge funds benefit the economy by mitigating price downturns, bearing risks that others will not, making securities more liquid, and ferreting out inefficiencies.

Those benefits are possible because hedge funds are subject to much less regulation than most investment companies. Compared to mutual funds, hedge funds are less restricted in their use of derivatives and leverage, and have greater incentives to do so because they are not required to disclose their strategies or holdings publicly.

Reason for growth in India:

There have been a lot of changes in the world economy over the last 6 decades. We have witnessed the rise and fall of nations such as Germany, Russia, Japan, Singapore and whole lot of others. This trend only proves to us that the state of the world economy witnesses' change at a constant rate and what is certain and prevalent now may not be the same in the future.

According to the recent study by Goldman Sachs it was learnt that the next fifty years could witness a drastic change in the world economy, countries like Brazil, Russia, India and China could emerge as super powers in the next 50 years.

The results are startling. If things go right, in less than 40 years, these economies together could be larger than the G6 in US dollar terms. By 2025 they could account for over half the size of the G6. Currently they are worth less than 15%. Of the current G6, only the US and Japan may be among the six largest economies in US dollar terms in 2050.

As early as 2009, the annual increase in US dollar spending from these countries could be greater than that from the G6 and more than twice as much in dollar terms as it is now. By 2025 the annual increase in US dollar spending from these countries could be twice that of the G6, and four times higher by 2050.

A few of the factors that are influencing this change are:

Ð'* Rise in Income

Ð'* Rise in working age population

Ð'* The Growth in the economy may fuel the demand growth and hence the consumption and investment levels would increase.

Hedge Funds: Some Basics

Hedge funds typically are exempt from the registration and disclosure requirements of federal securities laws, including the Securities Act of 1933, the Securities and Exchange Act of 1934 (Exchange Act), the Investment Advisers Act of 1940 (Advisers Act), and the Investment Company Act of 1940.

Despite the exemptions, hedge funds are subject to government regulation and oversight. Federal securities law prohibits hedge funds from fraud and insider trading. In 2006, 86 percent of hedge funds were registered with some regulatory body (such as the Securities and Exchange Commission or Commodity Futures Trading Commission), according to a Hennessee Hedge Fund Management Survey.

Hedge funds must make substantial disclosures to potential investors in order to discharge fiduciary duties and avoid running afoul of anti-fraud rules prohibiting "misleading statements" and "omissions." The Exchange Act requires hedge funds to report to the SEC any nontrivial holdings in public companies, and also all of their stock holdings on a quarterly basis if the fund has more than $100 million invested in public companies.

Reduced regulation also raises important concerns about the risks the funds pose to investors and the funds' potential to destabilize the economy Ð'-- the latter concern underscored by the spectacular 1998 contraction of the fund Long-Term Capital Management (LTCM). These worries have led to calls for tighter regulation or oversight, though the concerns turn out to be less substantial when considered carefully; hedge funds are reducing their risks for investors and other market participants. More regulation may reduce hedge funds' benefits to investors and the economy; policymakers should consider whether additional regulation will do more harm than good.

PERFORMANCE

In contrast to traditional mutual funds, the goal of most hedge funds is to deliver positive (absolute) returns in both up and down markets. This is possible because, not being subject to most trading regulations; hedge funds may engage in short selling and other trades to profit from downturns. As a class, hedge funds deliver positive returns but do not always beat general market indices or mutual funds.

More generally, when taking risk into account, researchers have found that hedge funds deliver investors superior risk adjusted performance Ð'-- so-called "alpha" Ð'-- in both up and down markets. However, some find that alpha may now be decreasing because the growth in investment in hedge funds means that more money is chasing relatively fewer opportunities, and there is debate about how long the superior performance will persist.

The Sharpe ratio provides a measure that appropriately adjusts returns for the level of volatility. It is the mainstay of Hedge Fund Statistics. The Sharpe ratio basically indicates that the higher the ratio, the better is the risk adjusted returns.

Sharpe Ratio = Return Ð'- Risk-Free Rate

Volatility

While some types of hedge funds exhibit erratic returns or an unusually high risk of negative performance, what matters to investors is not the risk of a single fund in isolation, but the potential for several funds to improve an already diverse investment portfolio.

For example, pension plans find hedge funds attractive