Hedge Funds - Hedge Funds
Hedge funds are aggressively managed portfolios that use advanced investment strategies in effort to generate high returns (either in an absolute sense or over a specified market benchmark). They can be thought of as mutual funds for the super rich. They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more flexibility in its investment strategies.
It is important to note that hedging is actually the practice of attempting to reduce risk, but the goal of most hedge funds is to maximize return on investment. The name is mostly historical, as the first hedge funds tried to hedge against the downside risk of a bear market, by shorting the market (mutual funds generally can't enter into short positions as one of their primary goals). Nowadays, hedge funds use dozens of different strategies, so it isn't accurate to say that hedge funds just "hedge risk." In fact, because hedge fund managers make speculative investments, these funds can carry more risk than the overall market.
Structurally, a hedge fund has some similarities to a mutual fund. For example, just like a mutual fund, a hedge fund is a pooled investment vehicle that makes investments in equities, bonds, options and a variety of other securities. It can also be run by a separate manager, much like a sub-advisor runs a mutual fund that is distributed by a large mutual fund company. That, however, is basically where the similarities end. The range of investment strategies available to hedge funds and the types of positions they can take are quite broad and in many cases, very complex. We will focus on specific strategies later in this section, so for now we'll focus on how hedge funds are structured.