Category ArchiveFinance

Hedge Funds

What are Hedge Funds?

Hedge Funds are minimal regulated investment partnership which uses a wide range of investment techniques and an array of assets that will generate a high return for a given level of risk.

Hedging means reducing risk, which is what many hedge funds are designed to do, a bit like making a risky bet with a person before making a conservative bet on the side.

Hedge Funds are managed to generate a consistent level of return, regardless of what the market does, although the risk remains, no matter the hedge fund strategy, though some hedge funds can generate a high level of returns for their investors, and others are unfortunate and don’t make a profit but end up making a loss.

In April 2012, the hedge fund industry had reached a record high of US$2.13 trillion total assets under management.

Another difference from normal mutual funds is the Manager Bonuses, a lot of hedge funds have a structure in place such as 2% & 20%  this means the hedge fund manager is paid an annual fee equaling 2% of the assets in the fund plus an additional bonus of 20% of the funds yearly profits. The hedge fund managers only receives a bonus if the hedge fund makes money.

The main component of hedge fund strategy involves selecting investments including: commodities, equities, fixed income and currency.

Hedge Funds Stocks and Shares

Leverage

A hedge fund will borrow a lot of money to maximise it’s returns, but this technique will also increase the funds risk, most funds will use leverage to increase the returns relative to the amount of money which they have in their account, though because of the high risk of using leverage, only investments which are considered to be of low risk tend to be used. Most hedge funds using leverage are likely to engage in extensive risk management practices.

Although compared to investment banks, hedge fund leverage is rather low; according to a National Bureau of Economic Research working paper, the average leverage for investment banks is 14.2, compared to between 1.5 and 2.5 for hedge funds.

Hedge Fund Managers

  • George Soros of Quantum Group of Funds
  • Bill Ackman of Pershing Square Capital Management LP
  • Paul Tudor Jones II of Tudor Investment Corporation
  • David Einhorn of Greenlight Capital,
  • Steven A. Cohen of Point72 Asset Management – formerly known as S.A.C. Capital Advisors
  • John Paulson of Paulson & Co. whose hedge funds as of December 2015 had $19 billion assets under management, compared to $18 billion in September 2013 and $36 billion in early 2011

Are some of the most well known of hedge fund managers.

 

The City

 

The City

The City it’s primary function is to put people who want to lend money in contact with those people who want to borrow money, so the financial institutions are there to channel funds of those lenders to the hands of the borrows. So why do the savers not just lend directly to the borrows, without the intervention of financial institutions? The reason is that the lenders needs are not always compatible with those of the borrowers.  People with mortgages want to borrow for many years (in most cases 25 Years) and savers may want to withdraw their money at anytime, but also, the amounts needed are dissimilar.

Governments and Companies also need to borrow amounts that are far beyond the the funds held by individuals. So only by putting all the savings of many many individuals can the financial institutions provide funds on each scale of need and generally the only part of the Economy in general who are net savers, is the private sector, rarely do we lend directly to the governments or industries, we save through the medium of banks and/or building societies.

So the financial institutions are there to channel the funds of those of savers and want to lend money, to those who want to borrow, (with a cut as the middlemen), this is done by charging higher interest rates to the borrows than who the pay to the lenders, or they can simply charge a fee for bringing together a lender and borrower.

There is little doubt that the financial institutions perform a valuable service,  how could the world function without cash points, credit cards, loans and mortgages. The financial institutions in the city form a vital part of the British Economy.

Other financial institutions known as Investment Banks, Pension Funds and Life Insurance Companies bundle together the monthly savings of individuals and then invest them into a wide range of assets, these include shares, bonds and commercial property. Another group is the exchange (Stock Exchange), which provide a market for trading capital the companies and governments have raised, people are more willing to invest money in tradeable assets as they can very easily reclaim the money as and when the need arises.

Tradeable assets

Financial assets, can be divided into four types: Loans, Equities, Bonds, Derivatives.

Loans are pretty simple, when one party has agreed to lend another party money for an additional payment (known as Interest) to be paid back over an agreed time period.

Equities or more commonly known as Shares, are issued by companies and offer a share in the profits the company makes. They differ from other financial assets in that they can provide ownership of the company. Companies generally announce an annual and/or quarterly dividend which is a sum payable to every shareholder as a proportion of the profits made.

Bonds are pieces of paper (basically an IOU) the borrowers (mainly Governments) issue in return for a loan and are bought by investors, who can then sell them on to other investors. Bonds are mainly medium to long term (5 – 20 years), the period which the bond lasts is called as a maturity, and the interest rate the bond pays is called a coupon. British Government Bonds are commonly known as Gilts and US Government Bonds are known as Treasury Bills or T-Bills for short.

Derivatives are financial assets which are based on other products and the value of the products is derived elsewhere, the most common derivatives are instruments such as futures, swaps and options. They allow for investors to insure against prices moves in other assets and for others to speculate on a price change, they also allow the users to hedge and leverage. Hedging is a process wheres an institution buys or sells a financial instrument in order to offset the risk of the price of another financial instrument and/or commodity may rise or fall. Leverage is an opportunity for a large profit with a small stake, Forex offers the chance to leverage.

The City is the financial capital of the world with many banking and insurance institutions having their headquarters there.

The London Stock Exchange, Lloyd’s of London and the Bank of England are all based in the City and over 500 banks have offices in the City, it’s also an established leader in trading in Forex and global insurance and accounted for 2.4% of UK GDP.

London is the world’s greatest Forex market, with much of the trade conducted in the City of London. Of the $3.98 trillion daily global turnover, as measured in 2009, trading in London accounted for around $1.85 trillion, or 46.7% of the total.