An investing fund or group, usually in the form of a limited partnership, that employs non-traditions techniques (hedgeing or speculative)in the hope of obtaining large capital gains. It is a complex financial investment instrument.

A hedge fund is an investment fund with high risk and its goal is to maximize profitability while minimizing the risk to which the investor is exposed to, for which hedging techniques are used. This fund is characterized as being a private company, normally a limited liability company, with a reduced number of participants (100 max.), and it is usually registered in tax havens. They mainly invest in highly leveraged companies.

The term was first used in a fund that Alfred Winslow Jones created, which combined short and long positions in securities, with the purpose of covering portfolio assets from movements in the market. A hedge fund is a privately organized collective investment fund, managed by professional societies that collect commissions from the profits they earn. Investment accessibility is restricted due to minimal funds for investment being very high. These funds follow absolute returns instead of relative returns in a benchmark index by using financial investment techniques not allowed for traditional funds such as an uncovered sale, the use of derivative products or the purchase of securities by aggressive leverage.

Also, this investment structure has minimum regulation and is subjected to lower needs of information. This means that hedge funds are funds that invest their capital in products that in general are banned or restricted to other traditional investment funds, such as uncovered stock sale, asset swaps, futures, options… A hedge fund is usually structured as a capital-based company, where its main participant becomes the manager and therefore also becomes responsible for the investment decsions, while the rest of the associates are considered investors.

Mainly, they are registered in fiscal havens such as Ireland, Luxembourg, Caiman Islands, etc., not so much for tax evasion but more so for the speed its legislation allows when setting up such funds, and the regulatory ease these places offer because they have few operating and taxation restrictions. hedge funds’ also introduce the “Prime broker” figure, which is the intermediary through which which the transactions are made, and acts as a non-interested party that must look out for the managed assets.

Also, in case you want to commercialize the fund in the different financial markets, you have the obligation to register it in the corresponding organism belonging to each country.

Some of the main characteristics of the hedge funds are the following:

  • They are investment packages not available to all investors because they require minimum amounts of initial investment that are very high, and they are managed by professional companies (investment banks or fund managers).
  • They search for assets that offer a higher expected return, different from a rational investor who searches assets with a better risk/return relationship.
  • It uses techniques not allowed for traditional funds
  • They are not regulated or obliged to give information about their transactions.

The investment strategies that hedge funds follow may be broken down into the following guidelines:

  1. Relative value: two or more positions in different instruments and of contrary sense (cancel systematic risk, and decrease risks such as credit, currency, long-lasting risk, etc.)
  2. Event-Driven: exploitation, by taking a short or long position, of an event (such as suspension of payments) or a corporative action (merger, absorption or acquisition).
  3. Opportunistic: bets on the veracity of the price expectations in the market, exposing to a huge risk in the market. Macro techniques, emerging markets, equity hedge and long/short equity stand out.

Hedge funds manage huge volumes of equity capital around the world and it has been noted that their return has been higher than most traditional investment funds. Leading these funds we may find finance gurus such as George Soros or James Simons, along with others, and many say the hedge funds with complex derivatives were responsible for the financial crisis in 2008 and for speculative attacks against European countries´ sovereign debt.