Types of Hedge Funds
Types of Hedge Funds. What are the main hedge fund types? Factors you must consider when choosing a hedge fund to invest in.
There are many kinds of hedge funds that differ in objective, in strategy, in liquidity requirements – here is a quick run-through of the most important differentiating factors.
Hedge Fund Objectives
Regardless of the type of hedge fund, most hedge funds aim to achieve a rate of absolute return that exceeds the rate of inflation. Unlike mutual funds, hedge funds measure their performance in absolute terms; even if the market were a bear market, hedge fund managers do not seek to merely make less losses than market indices – they seek to make absolute profits regardless of market circumstance.
Some types of hedge funds measure their performance primarily against other hedge funds, though absolute performance is the most important guiding factor.
Hedge Fund Strategy
This is where the largest disparity occurs among the different types. The broad investment approaches are the following: the directional or tactical investment approach, arbitrage or relative value investment approach, event-driven investment approach, or a hybrid investment approach. More on the specific hedge fund strategies.
Fund of Hedge Funds
What are funds of hedge funds? These are essentially hedge funds that invest in other hedge funds. Investing in a number of direct hedge funds provide diversification benefits while lowering risks, as multiple asset classes are combined.
‘Lock up’ refers to the period of time new investors must wait before they are allowed to invest in the fund. It describes the lack of liquidity in hedge funds. From the risk/return perspective, however, this is not necessarily bad for investors, as the freedom of time gives the professional hedge fund manager the ability to take advantage of investment strategies that may not otherwise be possible.
For some hedge funds, it may be a few years. For others, it may be a year or so. Generally, the more established the hedge fund, the less liquid it would become.
Types of Hedge Funds
Hedge fund objectives, hedge fund strategies and liquidity levels are the three most important factors to consider when deciding on a hedge fund. Other crucial factors include the fund’s historical returns, current management and the management fees charged. More on hedge fund manager compensation.