When a person thinks of hedge funds, buzzwords such as "very high risk" or "high returns" often come to mind. But what exactly are hedge funds and how do they work? In this article, we will show you a definition, differences to traditional investment funds, possible strategies and the risks involved.
Hedge fund definition
Hedge funds are actively managed funds. Here, there are professional fund managers who take over the composition of the portfolio and consciously select positions. At the same time, they are subject to fewer regulations from the German Federal Financial Supervisory Authority (BaFin).
The aim of a hedge fund is to achieve a Highest possible return to achieve. The aim is not to spread the risk as widely as possible and thus achieve a high level of diversification. Risks are consciously accepted in order to achieve the goal of a high return. The strategies used can vary greatly.
Hedge funds are alternative investment funds that are not traded on the stock exchange. They can invest in a wide variety of asset classes: Shares, bonds, commodities, precious metals and currencies can be bought, but leverage and short selling can also be used.
With hedge funds, it is also possible to invest in Derivatives to invest. Hedge funds are therefore not always dependent on rising share prices. If speculation has been made on falling prices, returns can still be generated.
This type of investment is often characterized by a Very high minimum investment amount of several hundred thousand. A high income is therefore required to be able to invest in such a fund.
What is a hedge fund? - Differences to investment funds
One thing the two types have in common, for example, is that they are both put together by an active manager. This manager decides on the strategy to be used. There are some aspects in which hedge funds and traditional investment funds differ:
| Classic investment fund | Hedge funds |
| Securities purchases | Securities purchases, derivatives and short sales possible |
| Investments are subject to strict regulation | Significantly fewer regulations |
| The aim is to beat the market return | The aim is to achieve the highest possible performance |
| Protection of investors secured by law | Little protection for investors |
| No borrowed capital | Use of borrowed capital possible |
| Performance dependent on the development of the overall market and the positions held | Performance primarily dependent on the strategy and expertise of the manager |
How do hedge funds work?
There are several different strategies that hedge fund managers can use to achieve their goal of maximizing returns:
- Global macro strategyThe aim is to achieve a high return with the help of trends. Markets are observed at the macroeconomic level (holistically). This analysis is used to identify opportunities that can be systematically exploited. The trends can result from political, economic or social developments.
- Long-short strategyThis strategy is applied by the fund manager speculating on the future development of company prices. The managers can speculate that shares will rise (long position) or that shares will fall (short position). This is the most widely used strategy.
- Arbitrage strategy/ relative value strategyThis strategy exploits differences between prices on different markets at the same time. For example, shares are bought at a low price on one market and sold at a higher price on another market.
- Event-driven strategyWhen fund managers follow this strategy, the aim is to try to take advantage of upcoming events. These include, for example, planned takeovers or restructuring of companies that have run into financial difficulties.
Investing in hedge funds - what are the risks?
One risk associated with hedge funds is the Dependence of the fund manager. This person is largely responsible for the positions and the strategy used. The fund therefore depends on his experience and knowledge.
Also the Low regulation is a risk that investors have to accept. Investor protection is significantly lower here than with conventional investment funds. A total loss can occur.
In times of Financial crises There are risks for hedge funds, which became apparent during the financial crisis in 2008. Some investors suffered major losses and many funds were closed.
The Leverage effect is associated with major risks. It can Debt capital be used in the form of loans to take advantage of leverage effects. However, this approach is risky: if there is a negative leverage effect, the actual loan amount including interest must be repaid.
In addition, used Short sales speculative. Investors speculate that certain prices will fall. However, these developments are unpredictable and unexpected changes can occur quickly.
Hedge funds Germany
Access to hedge funds is difficult for private investors. There are now only a few types of hedge funds in Germany in which investors can invest. These include Single hedge fundaimed at professional or semi-professional investors.
In addition, there are so-called Fund of hedge funds. They contain a large number of different hedge funds. These hedge funds are subject to certain regulations, for example that an investment in a particular hedge fund may not exceed a fixed percentage value. In this way, diversification can be increased somewhat. A statutory framework must be taken into account for short selling and leverage effects.
Conclusion: Hedge funds simple explanation
Hedge funds are subject to a active fund management. The fund manager selects positions and a suitable strategy in order to achieve the general goal of the highest possible return. The funds can invest in a wide variety of asset classes, including derivatives. Leverage and short selling can also be used.
Traditional investment funds and hedge funds differ, for example, in the degree of regulation. In addition, the aim of traditional investment funds is to beat the market return, while hedge funds aim to achieve the highest possible performance.
Fund managers can Different strategies apply. These include the global macro strategy, long-short strategy, arbitrage strategy and the event-driven strategy.
Hedge funds are fundamentally risky. Possible risks relate to the fund manager, the low level of regulation, financial crises, leverage effects, borrowed capital and short selling. In Germany, there are single hedge funds and funds of hedge funds.