A hedge fund is an investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio -construction and risk management techniques to improve performance, such as short selling , leverage and derivatives . Because of its use of complex techniques, financial regulators typically do not allow hedge funds to be marketed or made available to anyone except institutional investors , high net worth individuals and other investors who are considered sufficiently sophisticated.

Hedge funds are regarded as alternative investments. Their ability to make more extensive use of leverage and more complex investment techniques distinguishes them from regulated investment funds available to the retail market, such as US mutual funds and UCITS . They are also considered distinct from private equity funds and other similar closed-end funds , as hedge funds generally invest in relatively liquid assets and are generally open-ended , meaning that they allow investors to invest and withdraw capital periodically based on the fund's net asset value , whereas private equity funds generally invest in illiquid assets and only return capital after a number of years. However, other than a fund's regulatory status there are no formal or fixed definitions of fund types, and so there are different views of what can constitute a "hedge fund".

Although hedge funds are not subject to many restrictions that apply to regulated funds, regulations were passed in the United States and Europe following the financial crisis of 2007-2008 with the intention of increasing government oversight of hedge funds and eliminating certain regulatory gaps.

Although most modern hedge funds are able to employ a wide variety of financial instruments and risk management technique, they can be very different from each other in respect of their strategies, risks, volatility and expected return profiles. It is common for hedge fund investment strategies to aim to achieve a positive return on investment regardless of whether markets are rising or falling ("absolute return"). Although hedge funds can be considered risky investments, the expected returns of some hedge fund strategies are less volatile than those of retail funds with high exposure to stock markets, because of the use of hedging techniques.

A hedge fund typically pays its investment manager a management fee (for example, 2% (annualized) of the net asset value of the fund), and a performance fee (for example, 20% of the increase in the fund's net asset value during a year).

Hedge funds have existed for many decades, and have become increasingly popular. They have now grown to be a substantial fraction of the asset management industry, with assets totaling around $ 3.2 trillion as of 2018. Some hedge fund managers have several billion dollars of assets under management (AUM).

Seat and legal form

Many hedge funds are registered in offshore financial centers ; However, the AIFM Directive stipulates that the fund domicile is irrelevant for fund managers based in the European Union. In this case, the hedge fund is still subject to regulation. The reasons for choosing an offshore financial center are, on the one hand, of a tax nature ( low-tax country ), but on the other hand, there are also fewer restrictions due to the respective capital market legislation with regard to the financial instruments permitted in the funds. The British Financial Market Authority FCA reported in its June 2015 Hedge Fund Survey that 69 percent of hedge funds were in the Cayman Islands , 10 percent in Ireland , 8 percent in the US , 5 percent in the British Virgin Islands and the remaining 9 percent in the Bahamas , in Guernsey and are based in Luxembourg .

Anglo-Saxon hedge funds are more like closed-end funds in some ways. Investors acquire shares in these companies. The legal form corresponds to an English limited partnership (LP) or English limited liability partnership (LLP) of a German KG or an English limited liability company of a GmbH . In the LLP there are one or more hedge fund managers who are liable with their private and business assets, and investors who buy shares in these companies. Often the official seat of such a hedge fund is a tax haven (75 percent in the Cayman Islands ) and the fund manager is located in a financial center (e.g. London, New York).

The success of a hedge fund depends to a large extent on the skill of the fund manager and the quality of the mathematical / econometric models he uses, which are based on the Black-Scholes model, for example. The fund manager's approach is similar to a bet due to the high degree of risk and speculation. Borrowing up to a multiple of the equity is common in order to increase the return even more (leverage effect). Fund managers are expected to have a stake in the fund and, if necessary, have personal liability. In return, the managers are paid very well, the 2/20 rule is often spoken of. This includes a 2 percent management fee (of the fund volume) and a 20 percent profit sharing.

Hedge fund strategies

The investment strategies of the hedge funds can be differentiated as follows with regard to the market risk.

• Relative ValueEvent DrivenDirectional

• Convertible ArbitrageRisk ArbitrageGlobal Macro

• Fixed Income ArbitrageDistressed SecuritiesEmerging Markets

• Equity Market Neutral

With the “Relative Value” strategy, the market risk is comparatively low, it increases with “Event Driven” and is highest with “Directional”.

The first hedge fund strategy (market-neutral strategy) comes from Alfred Winslow Jones and was intended to be an instrument to protect against adversity in the case of interest rate and currency risks. Jones' idea was not only to profit in boom phases in interest and currency markets, but also to make profits when interest and exchange rates fell. With this, Jones founded one of the first hedge fund strategies, namely the one to take up debt capital (leverage effect, margin trading ) and short selling for the purchase and sale of currencies. He sold borrowed shares and speculated that he would be able to buy them back cheaper before the end of the loan period.

A group of new strategies (global macro strategy) were developed by George Soros and Jim Rogers with their hedge funds of the series Quantum Funds. Using new financial instruments, they speculated in new areas such as the foreign exchange market , interest rates , commodity and stock markets . Since Jones' first hedge fund strategy, hedge fund strategies have evolved and grown significantly. Hedge funds belong to the "alternative forms of investment". Hedge funds use the multitude of trading objects and trading strategies . Borrowed capital is raised because it is expected to generate a return that exceeds the cost of capital. The functioning of the leverage is based on a lower interest rate on the debt than the gain on the expected return. The leverage effect can, besides by backing a fraction of the exposure for exchange traded futures ( Futures ), in other hedge fund strategies are built only by borrowing. A small amount of outside capital is offset by a high volume of the traded base value . A high use of debt capital with a high leverage effect is common in the strategy of market-neutral arbitrage and global macro strategies.

Today, hedge funds are independent investment instruments with very different strategies and risk profiles. What they all have in common is the aspiration to generate profits in both rising and falling markets.