Beyond stocks and bonds: the world of alternative investments (Andrei Karpushonak)

Alternative investments, such as PE funds, differ from traditional investments, such as stocks, bonds or mutual funds. This article will focus on another alternative investment structure - hedge funds. 

Hedge funds in the 1990s

By the early 1990s, investing had entered a golden age in the USA. More Americans owned investments than ever, pushing stock prices much higher. Fewer than 6 million people worldwide counted themselves as dollar millionaires, with a total of $17 trillion in assets. Newly-made millionaires were looking for new venues to invest their savings. New capital created a demand for private and largely unregulated investment pools for affluent investors - a hedge fund as a limited partnership of private investors. 

Hedge funds structure

Professional fund managers are in charge of hedge funds. Hedge funds keep their portfolio hidden. They are not required to be registered with the regulator (in the US, it is the Securities and Exchange Commission - SEC). Usually, the SEC, like any other regulator in the rest of the world, would regulate investment opportunities to protect regular investments from losing money by introducing structure and guidelines and monitoring such investment opportunities. Only a small group of institutions and wealthy investors can invest in hedge funds. Hence, the regulator just needed to make sure to define who is an accredited investor. Only accredited investors can invest in such products and are solely responsible for their losses.     

Hedge and PE funds similarities

Similar to hedge funds are Private Equity (PE) funds. They tap into the same pool of investors: high-net-worth individuals and institutions. The difference is that private equity funds invest directly in companies. They could buy private companies or acquire a controlling interest in publicly traded companies. General Partners (GP) run private equity funds. Investors became limited partners (LP). There is also a fund of funds aggregating various PE funds into one product to diversify. 

Hedge and PE funds differences

Hedge funds invest in more diverse financial instruments than PE funds, which focus on individual companies. A hedge fund's life cycle is generally shorter than PE funds, where J Curve describes the fund returns. J Curve looks like the letter J, which has negative returns in the first years and flips to profits in subsequent years. Hedge funds can be riskier than traditional investments, while private equity funds are generally considered higher-risk, higher-return investments.

Summary 

In conclusion, hedge funds are a type of investment fund that employs various strategies to generate returns for their investors. These strategies can include long/short equity, market neutral, and global macro, and they often involve leverage and derivatives. Hedge funds are generally open to a broader range of investors and operate more flexibly than other investment funds. However, it's important to note that hedge funds can be riskier than traditional investments, and it is essential

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