Introduction to Hedge Funds

By Arjun Chandrasekar.

Overview

Hedge funds are partnerships between investors and fund managers to facilitate large investment deals. The fund manager seeks to maximize their client’s returns and eliminate as much risk as possible. As a general consensus, the target audience for hedge funds are the affluent, specifically those who have high net worths and are able to take financial risks. Mutual funds are considered polar opposites of hedge funds, as they are funds open to the general public while hedge funds are private investments. Hedge funds are additionally known to utilize high-risk investments, which provide opportunities for higher reward and return on investment (ROI).

The Process

Let’s quickly go over the process of the hedge fund client partnership. There are two sides of the partnership, general and limited. A hedge fund’s general partners are the fund managers, and they are responsible for controlling the investor’s money. They create the strategy for the investment and pay the money for it. On the other hand, the limited partners are the investors; they send their money to the general partner and ask them to invest it for them. In turn, the general partner receives a stake in the fund as a business commission. One key thing to note is that limited partners aren’t always individual investors, they can be represented as brokerage firms, investment companies, pension funds, and much more; however, the limited partners are always looking for a fund to invest their money with.

Advantages

Here are some of the advantages of investing with a hedge fund. First, of course, the general partner will manage your money and devise the investing strategies for you, leaving you free from that responsibility. Investing with hedge funds gives you access to diverse portfolios and high potential for profit, as it’s serviced by a professional manager.

Disadvantages

With all positives come negatives — let’s review some of the disadvantages of investing with hedge funds. First, the restrictiveness. Generally, hedge fund managers partner with investors that are “qualified”, or have a high annual income status of around $200,000+. This makes it especially difficult for the majority of the public to invest with hedge funds. Second, the risk. Hedge funds are able to invest in a wide variety of investments such as stocks, bonds, commodities, real estate, currencies, crypto, etc. They are consequently known to make riskier and more aggressive investments which may be a con for investors. Lastly, the general managers earn a bulky stake of the profits, usually at about 20%, limiting the amount of money the client takes in their pocket.

Popular Hedge Funds

So now that we’ve gone over the process and some attributes of hedge funds, let’s examine some of the most popular ones.

1. Bridgewater Associates
   1. Bridgewater Associates was founded by Raymond Dalio in 1975, and is the largest and most profitable hedge fund in the world. It has an AUM of approximately $235 billion. It’s headquartered in Westport, Connecticut, and has a total of about 1500 employees.
2. Renaissance Technologies LLC
   1. Renaissance Technologies was founded by James Simons in 1982 and is currently managed by Peter Brown and Robert Mercer, who are the Co-CEOs. It has an AUM of approximately $165 billion. It’s headquartered in East Setauket, New York, and has a total of about 275 employees.
3. AQR Capital Management
   1. AQR Capital Management was founded by Cliff Asness, John Liew, David Kabiller, and Robert Krail in 1988. It has an AUM of approximately $145 billion. It’s headquartered in Greenwich, Connecticut, and has a total of about 1000 employees.
4. BlackRock
   1. BlackRock was founded by Larry Fink in 1988. It has an AUM of approximately $9 trillion. It’s headquartered in New York, NY, and has a total of about 16000 employees.

*AUM = Assets Under Management, refers to the total market value of all assets the fund has.

Conclusion

In short, hedge funds create partnerships between limited partners who are the investors, and general managers, who work to create strategies and invest the money. Most of the time, hedge funds only allow investors who are well-off, meaning about $1 million+ in net worth, to invest with them. Although investing with hedge funds comes with many risk factors and exclusivity for the rich, with the right partnership, investors can get access to a diverse portfolio of holdings to increase their probability for larger returns.