Hedge funds are a fascinating area of work. At Cerrid, the subject interests us to the point, that we actually make a living out of providing specialized hedge fund analytics support to marque customers in the US! But more on that later…
In this post and subsequent ones, we would like to give an armchair observer’s view on the topic of hedge funds and risk management in general.
The history of hedge funds is interesting, controversial, and entertaining at the same time! For most of us, our first exposure to hedge funds comes from newspaper headlines describing spectacular gains or jaw-dropping losses (sometimes running into billions of dollars) made by some individuals or funds. The fact is that hedge funds form a very important daily component in the life of a financial market. In fact, hedge funds can account for upto half the daily trading on the New York and London stock exchanges! (Anderson, NYT, 2006)
You may not personally be qualified to invest in hedge fund yourself unless you are rich and meet SEC requirements. You may invest in a mutual fund though. The main difference between a mutual fund and a hedge fund is that the former is heavily regulated and hence considerably less risky than the latter. The flip side is of course, that the typical mutual fund can never provide the upsides that can potentially be reaped out of a hedge fund investment. This really is the classic risk-return trade-off.
Net-net, mutual funds are safer for personal investments but offer lesser returns. Hedge funds, on the other hand, are meant for sophisticated (and often rich!) investors who have a more nuanced understanding of the market and who are capable of absorbing considerable monetary shocks(!) in the event of a collapse