What Is A Hedge Fund, Anyway?

What is a hedge fund?
A hedge fund is an aggressively managed portfolio of securities set up for investors who have a net worth of over one million dollars. Investors who participate in a hedge fund have to sign a letter of agreement specifying that they are knowledgeable investors and that they are aware of the risks.

The hedge fund managers use advanced methods to maximize the return on investment to the fund. The techniques employ extremely leveraged positions in long and brief derivative positions in both domestic and international markets. Derivatives include possibilities (puts and calls), futures (contracts), and swaps, which they combine to protect the bulk of the portfolio. Most hedge funds (but not all) use sophisticated mathematical models to design protective "collars."

A typical requirement for hedge funds is that the investor should leave their investments in the fund for at least 1 year. To withdraw funds investors should notify the hedge fund manager within a narrow window (1 or two months) and at no other time.

Regulation
Because hedge funds don't deal with the standard public but with sophisticated "accredited" investors, they aren't regulated. Thus, managers have wonderful flexibility in their choice of instrument. Despite the fact that hedge funds resemble mutual funds, they aren't considered mutual funds (which are regulated and banned from working with derivatives).

However, since hedge funds participate in organized and regulated markets they grow to be topic to US law, and they may be scrutinized by the SEC and the Fed. In this respect, in spite of the fact that hedge funds aren't regulated, "insider trader" laws and other laws also apply to them.

Return on investment
Since sophisticated investors demand higher returns for their investments, hedge funds are designed to fill that need. As soon as a hedge fund can show a steady track record of high performance (much higher than the regular markets), dollars begins to flow in. The additional explosive the return on investment the higher the allure of the hedge fund.

Money Flow as a measure of liquidity, profitability, and future returns

No two hedge funds are alike they all function independently and in common they turn out to be a reflection of the personality of their managers, but in specific of the personality of the common partner.

Some general partners with cowboy personalities will ride more than all open fields: buyouts, IPOs, stock splits, arbitrage, and foreign currencies.

For several stock investors, the index "earnings per share" (EPS) is the absolute measure of profitability and an indicator of future corporate overall performance. For the hedge manager, on the other hand,

a considerably greater crystal ball is the corporation's statement of cash flows.

Why is the statement of money flows preferred by the hedge fund managers over the EPS? Hedge fund managers know that EPS can be 'doctored up,' manipulated, disguised, and shaped to look very good, when the underlying reality could be different-even grim. Money flows on the other hand can be double checked with the banks that hold the money accounts. The pieces that go into the preparation of the cash flows statement must fit perfectly and harmonize with the balance sheet and the income statement.

From the best section of the statement we read the inflows and outflows from the key line of enterprise-operations. From the middle section we read the investing activities: what cash was generated and applied by non-current assets and non-present liabilities. From the third section we can see the inflows and outflows due to dividends, and bond and stock concerns. The Statement of cash flows paints a detailed panorama of all the important activities that management engaged in throughout the year. Of most significance are the clues that the figures give to hedge funds managers as to the direction of the company: what plant expansions are taking spot, what restrictions are getting placed on retained earnings, and so forth. And if the firm is having difficulties with liquidity, this can be gleaned, too.

Hedge fund managers value fresh, existing, timely, and accurate info. Not only do they value facts, but they also cultivate good sources of info and connections. In this respect, hedge fund managers must tread lightly so as not to grow to be prey to "insider trading."

Many Brokers and Arbitrage
To squeeze the maximum return on investment, hedge fund managers employ several brokers, always seeking to make economies on broker fees and commissions. Given the volume and big amounts of income their savings can be considerable, which in the end will add to the fund's bottom line.

Once more, given the massive investments hedge funds can dump on brokers, they aren't too proud to engage in arbitrage. If they see that there's a price disparity in between exchanges, they will capitalize on it by crossing markets. Of course, most of these mispricing can be detected by personal computer programs that crawl the world wide web, pouncing on every chance and therefore eke out gains with no labor investment.

Conclusion:
Investors with cold blood in their veins, powerful hearts, and strong stomachs will entrust -risk, could be a superior word- their income to hedge funds. Is there any protection? None. They go into the funds with open eyes, trusting only the personality of the general partner.

May well universities, hospitals, museums, art organizations, and other non-for profit organizations invest in hedge funds? Yes, they may well. The overseers, trustees, directors, and in particular those in finance and investment committees will be deemed 'accredited' investors. And in keeping with their fiduciary responsibility they will follow the "prudent man" philosophy of diversification, investing only a fraction of their endowments.

Highfields Capital Management, LP is a privately owned hedge fund sponsor. The firm delivers its services to endowments, charitable and philanthropic foundations, pension funds, and other institutional and private investors It manages equity portfolios and hedge funds for its clients. The firm invests in the private and public equity markets of the United States, Canada, and international markets. It invests in value stocks. The firm also invests in lengthy-term mezzanine or other fixed income financing to fund enterprise acquisitions or growth and participates in leveraged acquire-outs, venture investments, and recapitalizations. Visit Highfields Capital.