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Hedge Fund

Definition

A hedge fund is a pooled investment vehicle that attempts to limit systematic (market risk) exposure as compared to a long only fund. In the classic sense of the term, a long-short hedge fund will buy or "go long" certain stocks that they expect to appreciate and sell or short other stocks that they expect to decline in value. If done appropriately, overall market exposure is reduced. For example, a long only fund may have 100% exposure to the S&P 500, so it will move in a very similar manner depending on its correlation. A hedge fund on the other hand may only have 40% exposure and correlation to the S&P 500 due to its short positions. If the portfolio is assembled and constantly monitored and adjusted correctly, then the fund may benefit from both gains on its long and short positions, while limiting its systematic risk from the broad market. This is the best case. There are significant risks associated with managing and investing in a hedge fund however.

Using the term Hedge Fund :

Mrs. Farkas, a high net worth investor, told her financial advisor that she would like to hire a fund manager that will reduce the volatility of her overall portfolio while still contributing gains. Her financial advisor recommends a long-short hedge fund to accomplish this goal.

Pay Special Attention To :

Hedge funds often utilize a significant degree of leverage (margin), which can cause portfolio pain quickly when things go wrong. They also often trade in illiquid securities, which are difficult to sell in bad market conditions. Hedge funds in the U.S. and many other countries are only available for accredited investors due to rules put forth by regulatory bodies.

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Related terms

Leverage, Illiquid , Alternative Investments , Hedging

'Hedge Fund' appears in the definitions of these other terms:

Alternative Investments