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Hedge fund definition

Hedge fund definition? Only a small proportion of the "hedge fund" universe actually are hedge funds. Performance independent of the market and risk-adjusted returns will show what is and what isn't a hedge fund. With hard work and experience we can determine those rare managers in ADVANCE. Absolute alpha NOT repackaged beta is the value proposition. True portfolio diversification is the only reason to choose a hedge fund.

1. A real hedge fund is designed to make money in ALL conditions. The function is not to beat an index in a bull market and preserve capital in a bear. A true hedge fund manager should relish a bear market regardless of their strategy. It comes down to generating consistent absolute returns at the lowest possible risk and INDEPENDENTLY of stock, bond, commodity and currency market conditions.

2. A real hedge fund manager does not make excuses. Any talk of "the economy is in recession", "other funds are crowding the strategy", "volatility was too low/too high", "there were no trends", "market conditions did not suit our methodology", "it was a bear market", or "a once in 100,000 year storm caused losses" are unacceptable. Make money or get out of the way. Give it back to investors so they can allocate to better managers. Anyone with skill evolves and adapts their strategy or finds new ones.

3. Hedge funds are NOT an asset class; they are strategy classes. They are a method of managing money that offers a LOWER risk alternative to the traditional buying and holding of assets. They may short sell or buy within and between different asset classes and associated derivatives. Diversification is the only way to spread asset risk; with strategies the depth of risk management tools is considerably more powerful.

4. A hedge fund manager is a risk manager. A hedge fund hedges; if it doesn't hedge then it is NOT a hedge fund. A hedge fund hedges either WITHIN its own strategy OR the strategy itself acts as a hedge, reducing the risk and volatility of a traditional portfolio. Long/short and arbitrage funds hedge. Short biased and managed futures do not hedge their own positions but their negative correlation to asset classes means they perform as a hedge. Even some long-biased funds such as activist investing or distressed debt can act as a portfolio hedge. However a long-only stockpicker is unlikely to offer any "hedge".

5. A real hedge fund is NOT an asset gatherer. A list of the world's BEST hedge funds is a very different list to the world's BIGGEST. Assets under management is the WORST criterion to assess a hedge fund. The management fee should not be a profit centre. Hedge funds charge higher fees due to the quality of staff, support infrastructure and technology necessary to identify opportunities and manage risk in today's markets. The performance fee is the ONLY profit centre in a real hedge fund.

6. A hedge fund invests the money of the principals of the firm and outside investors are then offered the chance to invest alongside. At least 50% of the liquid net worth of the principals, senior traders and salespeople should be invested in the fund. Many traditional long only firms have launched what they claim are hedge funds but if the senior management of the corporate parent are not heavily invested in that particular product, it is NOT a hedge fund.

7. A true hedge fund manager is NOT in competition with other hedge funds. She does not care how the index does or even how other managers are doing. Peer comparison is irrelevant. If she makes double-digit returns each and every year with downside deviation and worst drawdown a much lower, preferably single-digit number, then it is a hedge fund. How any other asset, product or manager performs does not matter.

8. A real hedge fund firm basically runs one fund. It may be multistrategy and it may have mirror or feeder structures and currency classes or varied leverage options, but it is basically a single fund. A sad development in recent years, copied from the mutual fund industry, is to have what purports to be a hedge fund "range"; the idea being that if you set up numerous funds it is certain that at least one will do well and you will have a track record to market. A true hedge fund firm lives (or dies) on its core product and focused expertise. And in which fund senior management keep their own money. I want alignment not a range.

9. A hedge fund is not mandate constrained. If you look at the best track records in history, the only common characteristic is the lack of arbitrary constraints on security selection. The manager needs to stay within their competence but basically they invest in any attractive opportunity they identify. One reason returns have reduced in recent years can be traced to constraints imposed by intermediary allocators afflicted with style drift paranoia. Investors pay hedge fund fees for skill, intellect and experience. Do the due diligence, but the manager should be left alone to get on with making money in the best and safest way they see fit.

10. Hedge funds are NOT just for the wealthy. Many institutions are now turning to hedge funds. Good hedge funds are a safer and superior investment vehicle. Several countries permit retail hedge funds to compete with traditional funds. It is only a few regulatory holdouts in certain legacy countries that due to mutual fund lobbying and vested interests "protect" retail investors from clearly superior financial products where manager and investor interests are better aligned.

By Hedge Fund Creative Commons License

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