Hedge Funds - The basics

Takeaways:

• Hedge funds aim at market neutrality and make money despite markets moving up or down.
• Hedge funds have aggressive goals and are lucrative in producing profits as they use techniques not available to mainstream fund managers.

What is it?

Hedge funds got their name from investors in funds holding both long and short stocks to make sure they made money despite market fluctuations (‘hedging’). But recently, hedge funds have many different structures with different assets and securities.

Typically, any investment pool contributed by a limited number of investors, operated by a professional manager with goals of maximising returns and minimising risk is a hedge fund. A hedge fund is not a type of investment. It is a means of investment.

Different types of hedge funds have different goals, but a common goal for all hedge funds is their aim at market direction neutrality, meaning they try to make money despite the market moving up or down.

How does it work?

A hedge fund investment structure is where a fund manager invests the money raised from outside investors according to whatever strategy the manager has promised to use. There are hedge funds that:

• Are “long-only” equities where they only buy stock and never sell short.
• Engage in private equity where private businesses are taken over, operations improved, and an IPO is sponsored.
• Invest only in real estate.
• Invest in specialised asset classes (patents, music rights, wine, rare stamps, etc.)

One of the biggest distinguishers about hedge funds is that they are almost always only available to accredited investors, and they have a “2 and 20” structure where an expense ratio and a performance fee are charged.

You can read about the types of hedge funds, their advantages, and their disadvantages here.

What is a “2 and 20” structure?

Most hedge funds operate on a “2 and 20” compensation structure consisting of a management fee and a performance fee. 2% represents the management fee which is applied to the total assets under management and a 20% fee is charged on the profits that the hedge funds generate beyond a specified minimum threshold. However, this structure has been widely criticised, given that even if the hedge fund loses money, the fund manager still makes 2% of the invested assets.

For example, if the hedge fund manager sets up a fund with a total investment of SGD 10 million from investors, the manager would get 2% of that amount (SGD 200,000) as a management fee. If the investments do well and the manager generates an additional SGD 2 million, the manager would walk away with an additional 20% (SGD 400,000) as a performance fee. Hence, hedge funds have very aggressive goals and are lucrative in producing strong profits.

How to invest

The universe of hedge funds is vast and, even within a particular strategy, the way the hedge fund managers invest can be unique. While investing in a successful hedge fund can offer high returns comparatively, there are also risks that investors need to be conscious of when deciding whether and how much to invest in a particular fund. Though hedge funds have historically been limited to institutional investors and the extremely wealthy, ADDX allows investors to buy into them for as little as S$10,000 (to participate in primary offerings) or even S$100 (to trade) and at a fraction of the fees!

ADDX is your entry to private market investing. It is a proprietary platform that lets you invest from USD 10,000 in unicorns, pre-IPO companies, hedge funds, and other opportunities that traditionally require millions or more to enter. ADDX is regulated by the Monetary Authority of Singapore (MAS) and is open to all non-US accredited and institutional investors.