Since the 2007 recession started we have heard a lot about hedge funds and how they have lost loads of money for their investors. The question most people have though is what is a hedge fund? And why can’t I invest in one?
Most people invest through their pension. The money they save in their pension is invested in the stock market for them by so called professionals. Your normal pension fund has only one investment strategy. It buys stocks and bonds only. The only way that fund will make money is if the market goes up. If the market goes down or stays where it is then the fund will probably lose money. Last year most funds of this nature lost over 60% of their value although some of these losses have now been clawed back following the market rally seen from March to December 2009.
A hedge fund though is not limited to just buying stocks and bonds. It can basically do what it wants. It can sell stocks or options (called “going short”) and invest in futures and commodities and debt. It can go long or short. Every fund though does have a very specific investment strategy that determines the type of investments and risks it undertakes. It is not the case you invest the money and the hedge fund managers can do what they want with it. You are told before hand what type of investments the fund will make.
The name “hedge fund” comes from the ability for these funds to go short to hedge their risk. For example, if the fund has bought lots of stocks then it might buy a put on the Dow Jones index which means if the stock market goes down, then where the fund will lose money on the stocks they have bought, they will make money on the put. So can anyone invest in hedge funds? Well alas no. You typically have to be a professional or very wealthy investors.