For an investor who already holds large quantities of equities and bonds, investment in hedge funds may provide diversification and reduce the overall portfolio risk.[85] Managers of hedge funds use particular trading strategies and instruments with the specific aim of reducing market risks to produce risk-adjusted returns that are consistent with investors' desired level of risk.[86] Hedge funds ideally produce returns relatively uncorrelated with market indices.[87] While "hedging" can be a way of reducing the risk of an investment, hedge funds, like all other investment types, are not immune to risk. According to a report by the Hennessee Group, hedge funds were approximately one-third less volatile than the S&P 500 between 1993 and 2010.[88]
Investable indices are an attempt to reduce these problems by ensuring that the return of the index is available to shareholders. To create an investable index, the index provider selects funds and develops structured products or derivative instruments that deliver the performance of the index. When investors buy these products the index provider makes the investments in the underlying funds, making an investable index similar in some ways to a fund of hedge funds portfolio.

Within the European Union (EU), hedge funds are primarily regulated through their managers.[71] In the United Kingdom, where 80% of Europe's hedge funds are based,[218] hedge fund managers are required to be authorised and regulated by the Financial Conduct Authority (FCA).[193] Each country has its own specific restrictions on hedge fund activities, including controls on use of derivatives in Portugal, and limits on leverage in France.[71]


Deutsche Bank and Barclays created special options accounts for hedge fund clients in the banks’ names and claimed to own the assets, when in fact the hedge fund clients had full control of the assets and reaped the profits. The hedge funds would then execute trades — many of them a few seconds in duration — but wait until just after a year had passed to exercise the options, allowing them to report the profits at a lower long-term capital gains tax rate.

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In addition to assessing the market-related risks that may arise from an investment, investors commonly employ operational due diligence to assess the risk that error or fraud at a hedge fund might result in loss to the investor. Considerations will include the organization and management of operations at the hedge fund manager, whether the investment strategy is likely to be sustainable, and the fund's ability to develop as a company.[92]
Relative value attempts to take advantage of relative discrepancies in price between shares. The price discrepancy might be between related shares, the underlying company or the market overall. These strategies do not have exposure to the market as a whole. The fund might look for two matching investments and go long in one and short in the other. There may be pricing inefficiencies in fixed income, between stocks in the same broad sector, between convertible shares and the underlying stock, etc.
Alfred W Jones, who was born in Melbourne in 1901, is credited with creating the first hedge fund in New York in 1949. Jones hedged his portfolio by buying shares whose price he expected to increase, and 'short' selling others whose price he expected to decrease. Short selling is selling shares that you don't actually own which means that you are going to have to buy them at some point in the not too distant future. While you know the price you have sold them for, you don't know what you are going to have to pay for them and is an inherently risky strategy but makes money if the share price goes down.
Hedge fund is a private investment partnership and funds pool that uses varied and complex proprietary strategies and invests or trades in complex products, including listed and unlisted derivatives. Put simply, a hedge fund is a pool of money that takes both short and long positions, buys and sells equities, initiates arbitrage, and trades bonds, currencies, convertible securities, commodities
There are many strategies a hedge fund may use to generate returns. One such strategy is global macros, where the fund takes long and short positions in large financial markets based on the views influenced by economic trends. Then there are funds that work on market-neutral strategies. Here, the goal of the fund manager is to minimise market risks by investing in long/short equity funds, convertible bonds, arbitrage funds, and fixed income products.
To make the index investable, hedge funds must agree to accept investments on the terms given by the constructor. To make the index liquid, these terms must include provisions for redemptions that some managers may consider too onerous to be acceptable. This means that investable indices do not represent the total universe of hedge funds. Most seriously, they under-represent more successful managers, who typically refuse to accept such investment protocols.

Relative value attempts to take advantage of relative discrepancies in price between shares. The price discrepancy might be between related shares, the underlying company or the market overall. These strategies do not have exposure to the market as a whole. The fund might look for two matching investments and go long in one and short in the other. There may be pricing inefficiencies in fixed income, between stocks in the same broad sector, between convertible shares and the underlying stock, etc.


Directional investment strategies use market movements, trends, or inconsistencies when picking stocks across a variety of markets. Computer models can be used, or fund managers will identify and select investments. These types of strategies have a greater exposure to the fluctuations of the overall market than do market neutral strategies.[68][71] Directional hedge fund strategies include US and international long/short equity hedge funds, where long equity positions are hedged with short sales of equities or equity index options.
In June 2011, the hedge fund management firms with the greatest AUM were Bridgewater Associates (US$58.9 billion), Man Group (US$39.2 billion), Paulson & Co. (US$35.1 billion), Brevan Howard (US$31 billion), and Och-Ziff (US$29.4 billion).[32] Bridgewater Associates had $70 billion in assets under management as of 1 March 2012.[33][34] At the end of that year, the 241 largest hedge fund firms in the United States collectively held $1.335 trillion.[35] In April 2012, the hedge fund industry reached a record high of US$2.13 trillion total assets under management.[36] In the middle of the 2010s, the hedge fund industry experienced a general decline in the "old guard" fund managers. Dan Loeb called it a "hedge fund killing field" due to the classic long/short falling out of favor because of unprecedented easing by central banks. The US equity market correlation became untenable to short sellers.[37] The hedge fund industry today has reached a state of maturity that is consolidating around the larger, more established firms such as Citadel, Elliot, Milennium, Bridgewater, and others. The rate of new fund start ups is now outpaced by fund closings.[38]
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Many hedge fund investment strategies aim to achieve a positive return on investment regardless of whether markets are rising or falling ("absolute return"). Hedge fund managers often invest money of their own in the fund they manage.[11][12] A hedge fund typically pays its investment manager an annual management fee (for example, 2% of the assets of the fund), and a performance fee (for example, 20% of the increase in the fund's net asset value during the year).[1] Both co-investment and performance fees serve to align the interests of managers with those of the investors in the fund. Some hedge funds have several billion dollars of assets under management (AUM).
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