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Phone: (519) 974-6688
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Hedge Funds

What is a Hedge Fund?

Hedge funds are investments that use a variety of non-traditional strategies to try to offset risk. These strategies employ long and short positions, use leverage, and derivatives, and are less dependent on market direction than long-only investments such as stocks, bonds, and mutual funds.

Hedge Funds are like mutual funds in two respects: (1) they are pooled investments and (2) they invest in publicly traded securities. But there are important differences between a hedge fund and a mutual fund.

Mutual Funds Seek Relative Returns

Most mutual funds invest in a predictable style, such as "large cap", or into a particular sector, such as the financial services sector. To measure performance, the mutual fund's returns are compared to a style-specific index or benchmark. For example, if you buy into a "large cap" fund, the managers of that fund may try to outperform the S&P 500 index. A mutual fund's goal is to beat the index. If the index is down 10% while the mutual fund is only down 8%, the fund's performance would be called a success.

Hedge Funds Actively Seek Absolute Returns

Hedge funds seek positive absolute returns, regardless of the performance of an index or sector benchmark. Unlike mutual funds, which are "long only" (make only buy sell decisions), a hedge fund engages in more aggressive strategies and positions such as short selling, trading in derivative instruments like options and using leverage (borrowing) to enhance the risk / reward profile of their bets. In a bull market, hedge funds may not perform as well as mutual funds, but in a bear market, taken as a group or asset class, they should do better than mutual funds because they hold short positions and hedge. The absolute return goals of hedge funds vary, but a goal might be stated as something like "6 9% annualized returns regardless of the market conditions".

Investment Considerations:

Risk

Although on of the main objectives of hedge funds is to reduce risk and protect your capital in down markets, they can be a risky investment. For example, hedge fund managers can make bad decisions resulting in poor performance. If a hedge fund uses leverage as a strategy, find out how much leverage the fund uses, since too much leverage means too much risk.

Fees

In addition to management fees that regular mutual fund companies have, hedge funds have performance fees that are paid if the fund meets certain performance targets. You should find out what these performance fees are before you invest. Since many hedge funds have only been introduced since the 2000 2002 bear market, they may not have long track records, making it difficult to assess and compare different funds. Check to see if there has been any manager turnover during the track record period to see who has been responsible for the fund's performance. When assessing a manager's track record, see how well they do in both bull and bear markets.

Fund of Funds

These funds invest in an number of different hedge funds, giving you diversification, across different managers and investment styles. The advantages of funds of hedge funds include automatic diversification, monitoring efficiency, and selection expertise. Because these funds are invested in a minimum of around eight funds, the failure or underperformance of one hedge fund will not ruin the whole. The biggest disadvantage is cost, because these funds create a double-fee structure. Typically, you pay a management fee and a performance fee to the fund manager in addition to fees normally paid to the underlying hedge funds.

Advantages:

  • The potential for a positive return, regardless of the market conditions.
  • Many hedge funds have very little correlation with the average stock or bond market investments.
  • The performance fee structure aligns the fund manager's interests with the investor's interests.

Disadvantages:

  • Most hedge funds have very high minimum investments in order to limit the number of investors in a particular fund.
  • Hedge funds are not as highly regulated as mutual funds, increasing the possibility of fraud.
  • Unlike mutual funds, hedge funds are not required to report returns on a regular basis.
  • Some hedge funds have "lock-up" provisions that require the investment to stay with the fund manager for a year or more before redemption can occur.
  • It is difficult to gauge when to take profit and rebalance this type of investment versus other traditional portfolio investments.

Mutual funds are offered through Manulife Securities Investment Services Inc. Insurance products and services are offered through Seguin Financial Group Ltd. Seguin Financial Group is a trade name used for both mutual fund & Insurance business activities. Banking products and services are offered through referral.

info@seguinfinancial.com