Everything You Need to Know About Hedge Funds
As the word ‘hedge’ suggests, it is an idea to secure the investor from incurring any losses first and then cater to his earning aspirations. It has been gaining a lot of traction in the 21st Century owing to its benefits over mutual funds and other investing techniques.
In this article, we walk you through the basics of hedge funds that you must acquaint yourself with before you begin investing.
What is a hedge fund?
A.W. Jones & Co. launched the world’s first hedge fund in 1949. A hedge fund is not an investment in itself, but is a type of alternative investment vehicle. It started gaining traction in the 1990s and has become one of the go-to ways for elite investors.
It pools money from a group of accredited investors and invests in a mix of long-short investment options. These offer more leeway than a regular mutual fund and hire a professional fund manager who manages the money on the investors’ behalf.
Types of hedge funds
The hedge fund manager can follow any from the hundreds of strategies available in the market or curate one for himself. Here are the most popular types of hedge funds that you are most likely to come across:
- Equity short/long
- Equity market neutral
- Event-driven investing
- Global macro
- Fixed-income arbitrage
- Convertible bond arbitrage
- Merger arbitrage
You can head over to our Types of Hedge Funds article to understand more about them.
Structure of a hedge fund
You are most likely to come across an LLP (Limited Liability Partnership) running a hedge fund. Here are its key components:
- Investors – Retail investors are not allowed to invest in a hedge fund. Only accredited investors (individuals exceeding specific annual income or net worth levels) can subscribe to acquire units of a hedge fund.
- Investment manager – An investment manager is a specialist who makes most of the investment decisions of the fund. He looks after the risk management aspect and makes the necessary adjustments.
- Prime Broker – Such a broker aids the fund manager in completing large significant transactions or in making trades with complex technicalities.
- Support Team – Responsible for maintaining back office functions such as technology, compliance and administrative parts of the fund.
Characteristics of a hedge fund
Most of the securities or investment plans that you invest have their own set of features. Here is what makes hedge funds different from others.
1. Accessible to accredited investors only
Like in the rest of the world, the hedge fund investment in Singapore is only accessible to accredited investors and some retail investors.
For meeting the former criterion, you must be an individual with net income of S$300K per annum, assets exceeding S$2 million (with at least S$1 million invested in property) or an organization with at least S$10 million net assets.
Retail investors can only invest in funds managed by Asset Management firms that have a CMS (Capital Markets Services) License for Retail Fund Management from the Monetary Authority of Singapore (MAS) under the SFA Act.
2. Plethora of options
Hedge funds don’t come with any such restrictions in the choice of strategies for the fund. The fund manager can invest in any asset class and do so in various structures or strategies to achieve a desired objective, as long as these are laid out clearly to investors. These may manifest in the form of varying levels of liquidity and drawdowns in the fund.
3. Unique fee structure
Hedge funds typically follow a unique “Two and Twenty” payment structure for the manager. The fund gets a 2 percent management fee irrespective of his performance.
If the returns in a period exceed a specific figure, the fund is eligible to charge a 20 percent performance fee, typically above a High Watermark.
4. Leveraging debt to produce equity returns
To accentuate the returns for the investors, a hedge fund manager may use borrowed money for investment purposes. It is a common strategy amongst alternative investment vehicles.
How to invest in a hedge fund
Planning to invest in hedge funds? Here are the things that you have to keep in mind.
1. In-depth understanding of the fund
It is imperative for you to understand the intricacies involved in the hedge fund before you get involved in it. For that, you can look into their fund prospectus.
Compare the investment objective(s) with yours and ensure that they are in sync. Also, do not focus on past performance alone. It is crucial to have an understanding of the risks involved before you decide to invest.
2. Make sure that you understand the fee obligations
As mentioned above, most funds of this type follow a ‘Two and Twenty’ rule. It means you will have to pay 2 percent of your total assets irrespective of the performance and an additional 20 percent performance fee for exceptional returns.
3. Have a look in its assets
Before you begin investing, look into the fund’s assets to understand the liquidity aspect. You can often come across instruments that can be difficult to sell when you need to redeem the units. If you have difficulty understanding the technicalities involved, Salzworth can be of help.
4. Understand the capability of the hedge fund manager
Since the investors allow the fund manager to take care of all the investing decisions, it is imperative that you take note of his capabilities. This is best achieved by meeting the fund manager in person to hear directly from the fund manager his experience and investment philosophy to ascertain if the fund caters to your objectives.
5. Take note of when you can redeem
Certain hedge funds may have rigid redemption terms such as long lock-in periods or high penalty fees. These may be lockdown periods where you cannot redeem your funds. Ensure that the redeeming facilities are in line with your expectations from the investment.
A hedge fund is a vehicle which offers investors access to a wide variety of strategies to gain returns that have little to no correlation to the broader financial markets. Most people claim it is speculative owing to the opaque nature of the industry and level of complexity in some of the methods employed, but there is much more to it.
Most hedge funds that you are likely to come across are restricted to accredited investors only and retail investors are not allowed to invest. The tenebrosity can at times put people in confusion about which hedge fund would be the best and how much they should invest.
At Salzworth, we employ experts to solve all your investing queries and ensure that you get the best recommendations in Singapore. Contact Salzworth for end-to-end plans on asset management, investment funds, family offices, etc.
More related articles:
- Types of Investment Funds in Singapore
- What is a Fund of Funds?
- What are Algo Funds?
- Shedding Light on Foreign Currency Denominated Funds
Co-Founder, Chief Executive Officer
Haruhito was the Executive Director of Marcuard Heritage Singapore Pte Ltd, a Swiss multi family office. He was instrumental in building up their European and Asian clientele base which comprised of a global network of asset managers, distribution partners, and legal & tax specialists. Prior to that, he held various positions for 10 years in Deutsche Bank where he gained extensive experience in various Asian markets.
Haruhito has been accredited as a Trust and Estate Practitioner (TEP) by STEP, and as a Financial Industry Certified Professional (FICP) by Singapore’s Institute of Banking and Finance. His vision for Salzworth is to steer it to establish multi-asset class portfolios and funds that seek to achieve steady returns for investors.