What is Hedging?
Hedging is a technique used by investors to protect their investments from risk. They achieve this by creating neutralizing circumstances using tools like options trading. Hedging is helpful for investors because it helps deflect adverse outcomes for a positive or better one. If you had a hedged fund, you would operate under minimal risk, and even if the worst were to happen, you would receive minimized losses compared to an investor who has not hedged their investments. Investors do not make money or profit from hedging, similar to insurance. They do, however, enjoy the protection and peace of mind it offers.
What is a Hedge Fund?
On the other hand, a hedge fund is an investment vehicle used by investors to pool their money and purchase more significant investments. Hedge funds are designed to bring investors greater returns than they get in the stock market or from other types of investments.
The name hedge fund was coined from the fact that the investments chosen are usually a tool for protection from a declining market or asset value. A hedge fund can invest in just about anything, including bonds, real estate and even cryptocurrency.
Hedge Fund Organizational Structure
There are several organizational structures used currently in hedge funds. They include;
1. Fund of Funds
This structure usually involves investing in other funds, including mutual funds or hedge funds.
2. Parallel Funds
A side by side hedge fund structure in the United States typically entails a domestic fund and a foreign fund running parallel to each other. Both accounts can operate on a symbiotic nature where if one makes a profit, the other is, in turn, guaranteed a profit.
3. Master Feeder Fund
This is a combined hedge fund structure in which offshore and domestic funds form a single offshore master fund. This structure uses offshore opportunities and trade loopholes to earn significant returns on investment.
What Do You Need to Invest in a Hedge Fund?
Not everyone can invest in a hedge fund. Here are some of the requirements you would need to fulfil before thinking about investing in a hedge fund
1. Net Income
To be eligible to invest in a hedge fund, an investor (individual or institution) has to earn an income higher than $200,000 per year. You must provide proof that you have made the same amount the past two consecutive years. Couples have to earn at least 300,000 dollars combined income per year and show evidence of the same for the last two years. The investor must also reasonably expect to make the same amount in the current year. The last option is to have a net worth of over a million dollars either alone or as a couple. When calculating your net worth, do not include the value of your primary residence.
2. Entity/ Institution
Institutions and trusts must have assets worth at least $5 million and be managed by a financially competent professional approved by SEC.
3. Net Worth
When calculating an investor’s net worth, it is essential to take proper stock of current liabilities. For example, if your mortgage/loan on your primary residence is more significant than its current market value, the portion of the loan exceeding market value is considered a liability.
Hedge funds rely on specific strategies to grow wealth. Some common techniques include arbitrage, credit funds and global macro.