For a variety of reasons, you may at some point find yourself with a significant amount of money you’d prefer to invest. Hedge funds are a common way to invest large sums of money, and if managed properly they can provide a huge return on investment. It’s not easy to understand the complex world of hedge funds however. Properly managing a hedge fund requires a deep understanding of financial markets and accounting principles. These funds capitalize on the a concept termed ‘hedging,’ which attempts to turn a profit regardless of the economic environment.
Hedge funds draw attention because they are dynamic and offer many different investment opportunities. They are not required to provide the same level of detailed data one would see provided a regarding a mutual funds, because hedge funds are private. The accountant running a hedge fund must only provide and annual audit, required by the IRS.
In order to properly manage a hedge fund, an experienced and talented accountant with knowledge of investments and markets will be required. Hedging uses ‘long’ or ‘short’ position on investments. A long position is more straightforward, the idea being that one purchases stock or an index and waits, hoping the value will increase. Things begin to get quite complicated when it comes to short positions. They are extremely involved and require a thorough understanding of borrowing and repaying, and selling and repurchasing to take advantage of a dropping market. Short investments are made in the hopes that stock values will decrease. The help of expert CPA firms is strongly suggest when trying to understand short positions.
In the end, hedge funds typically have an ultimate goal. They seek to provide an “absolute return,” or to turn a profit whether the market is trending up or down. It may seem implausible or even impossible, but it is, it’s just difficult and quite risky. Using a ‘long’ position to make an investment means you (or your investor) is confident that the assets will increase in value, while the opposite is true for a ‘short’ position investment. Hedge funds truly need to be managed by an individual with an immense knowledge of markets and investments. Making a profit isn’t easy in any economic climate, but hedge funds are expected to return a profit even in a down market.
One way managers accomplish this is by following a hedge fund strategy called the 130-30 strategy. It can be explained rather simply using stocks.
Check it out:
- A short seller investor invests $100 in a group of stocks believe to be undervalued.
- Using $30 of the worst-performing of the $100 worth of stocks as collateral, the broker borrows $30 worth of what is thought to be overvalued stock.
- The overvalued stock is sold right away, with hopes that its value (per-share) decreases quickly.
- After the stock’s value does decrease, for example to $10, it’s purchased again at the lower price.
- Then the broker returns the shares to the securities lender, who returns the $30 collateral for a profit of $20.
- This $20 is typically invested into the best performing stocks, and the process will be repeated.
Even if you’re not going to become a hedge fund manager, it’s key to understand the basics if you want to invest in hedge funds. It’s always a good idea to do some independent research if you’re interested in learning more about hedge funds, or you could talk to an accountant who specializes in hedge funds, and investor, or a different financial services provider.
Recently, hedge fund investments have become more accessible and available to “normal” people. Meaning, hedge funds used to the tool of only rich investors, but the economy has changed opening them up to more individuals. Keep in mind that information on hedge funds is much more limited than it is for other investment options. It’s much easier to get regular updates and financial data about these investments than it will be for hedge funds. Beyond an annual audit, you will not see much.
Speaking of the audits, they’re handled by independent accounting firms, completely unaffiliated with the hedge fund manager or investment group. The audits must be carried out in compliance set forth by the SEC (Securities Exchange Commission), and help investors understand where they stand. Typically the audit will carry an opinion aimed at verifying the accuracy and validity of the fund’s financial statements. The audit seeks to ensure that this information is being presented clearly and fairly to investors. The auditor must be thorough and become intimately familiar with the fund’s investments through testing. The fund’s procedures are check and made sure to be in line with the original paperwork regarding the fund. The audit will let investors know whether or not the fund is performing up to snuff.
Hedge funds are quite complex and need to be researched at length if one wishes to gain an expert understanding of them. This article gets you started on the right foot, but there is much more to learn.