Hedge Funds: What are they & How do they work

Mutual funds are a unique investment tool that give investors an opportunity to invest in markets and asset classes which would not have been possible otherwise. What fund houses do is that they collect money from investors sharing a common investment objective and invest this pool of funds across the Indian and foreign economy. Mutual fund investors also have the option of making small and systematic investments at periodic intervals, thanks to a powerful tool like SIP. There is also a SIP calculator available online for investors to get an estimate of how much they need to invest systematically in order to achieve their life’s monetary goals.

Although not the most popular investment tool among other mutual fund schemes, hedge funds are still in the initial phase here in India. They invest in various asset class and money market instruments by applying an investment strategy that will ‘hedge’ risk and provide investors with superior capital gains. The primary purpose of a hedge fund is to protect an investor’s portfolio against risk. A hedge fund generally accumulates funds from banks, insurance firms, endowments, pension funds and High Net-Worth Individuals (HNIs). An hedge fund currently functions as an overseas investment. This also means that they do not need to register themselves with Securities and Exchange Board of India (SEBI), nor do they need to publicly disclose their NAV like other mutual funds.

A hedge mutual fund’s portfolio consists of investments made in asset classes and money market instruments like derivatives, equities, convertible securities, currencies and bonds. A hedge fund needs aggressive fund management because their primary objective is to hedge the risk against volatile markets.

What are some of the features of a hedge fund?

Hedge funds only received a go ahead from SEBI in the year 2012. This makes the youngest mutual fund avenue available for Indian investors. Here are some of the features of a hedge fund:

Hedge funds are only available for high net worth grossing entities

As of now, hedge funds are only available for high net worth individuals (HNIs), banks, insurance companies, endowments and pension funds. The minimum investment value for owning a hedge fund is Rs. 1 crore. Only accredited and licensed entities can invest in hedge funds. This makes it almost impossible for a common investor to seek investments in a hedge fund.

Hedge funds have a higher expense ratio

Hedge funds have both expense ratio as well as management fee. In the international markets, they follow a ‘two and twenty’ ratio which means that a predetermined fee of 2 percent is levied on 20 percent of profits. Here, in India the management fee is anywhere from 1 percent to 2 percent for hedge fund investments. The profit sharing differs from anywhere for 10 percent to 15 percent.

Hedge funds carry a diversified portfolio

Hedge funds have the obligation of investing in all the asset classes as per the mandate. They are considered to carry a diversified investment portfolio because they invest in asset classes and money market instruments like equities, currencies, stocks, bonds and real estates.

Hedge funds are a high risk investment

Hedge funds generally come with a predetermined lock in period which is relatively longer. This is why there is a great chance of a hedge fund portfolio incurring great losses. Although hedge fund investments strategies are supposed to safeguard an investor’s finances, they can cause a hedge fund portfolio to incur losses.

These were some of the features and basic information about hedge fund investments in India. Since they are not available for commoners, high-net worth grosses eligible for investment in these funds should consult their financial advisor before making an investment decision.