Hedge funds

 

If you have ever had anything to do with the stock market or heard of its principles, you will probably have come across the words ‘hedge funds’ at some point, heard or read them somewhere – and maybe not really understood what they are the first time you did so. Their principles are quite complicated to understand; as with any type of investment, there are complexities involved. What is a hedge fund really and where do they come in when it comes to the current stock market crash?

What exactly is a hedge fund?

Hedge funds are a type of private investment funds that are open to a quite limited range of investors. Hedge funds can, by authorization of regulators, undertake a wider range of actions than other investment funds, and its investment manager gets a performance fee. There are different strategies and each fund will have its own. This determines the methods and the types of investment that it undertakes. Generally, hedge funds invest in quite a broad range of investments, including shares, commodities, debt etc. The goal of hedge funds is to create potential losses in the principal markets that they invest in, through hedging their investments in a variety of ways, especially short selling. However, many funds that do not hedge their investments have been called “hedge funds”, in particular if they use short selling and other methods typical to hedge funds, designed to increase rather than reduce risk, with the ultimate goal of increasing the expected return. Only a limited range of professional and wealthy investors can actually invest in hedge funds because only they are, in many jurisdictions, exempt from regulations that relate to liquidity of interests, leverage, derivative contracts, fee structures, short selling etc. Once an investor invests in a hedge fund, he will typically apply one particular investment strategy and particular investment types and leverage levels that will be stated in the offering documentation of the fund. This will help giving investors some indication of the nature of the fund. A hedge fund can have a net asset value up to many billions of dollars, which is then additionally multiplied by its leverage. Hedge funds are very present in quite specialized markets. What is important to know with hedge funds is that they are a type of investment with a very high risk involved, but that the potential financial gains are also very high. This is why, if hedge fund trading and investing is not sufficiently regulated, a crisis of a huge impact is likelier to break out than with other types of investment.

What role do they have in the stock market crash?

Hedge funds have been said to drive the stock market crash. Short-selling rules were changed, brokerages imploded and this reduced the possibility of borrowing money, so hedge funds have had to delever. As if this were not enough, many have been faced with redemption in the autumn of last year. These could lead to fire sales and mark the beginning of a vicious circle that it is hard to get out of. Also, given the higher risk and the higher possible financial gain that can come from hedge funds, the latter are responsible for a lot of capital that is exposed in the markets. Hedge funds have suffered massive share price falls, yet the hedge fund bosses have claimed that banks, not themselves, are responsible. Generally, though, it is accepted that hedge funds have indeed played an important part in the stock market crash that the world is facing today. Hedge fund managers have been blamed of making huge sums of money for themselves by investing in the stock market, thus disadvantaging the average citizen and the global economy through their own greed. It is true that a very small number of bankers have, despite the insecure financial situation, made enormous sums of money, and one might well ask where these came from so suddenly. There is no doubt that in most countries, regulation for the highly risky investment types that hedge funds are is insufficient and that as such, the risk of speculating with them is even higher and impacts on the stock market can be disastrous.