- a limited partnership of investors that invests in speculative stocks.
- a mutual fund that seeks to make money betting on a particular bond market, currency movements, or directional movements based oncertain events such as mergers and acquisitions. It attempts to hedge in order to minimize an exposure to currency risk. In general, international short-term bond funds usually hedge most of the currency risk, while longer-term funds have substantial exposure. Funds usecurrency options, futures, convertible bond arbitrage, merger arbitrage, and elaborate cross currency hedges, but the most effective hedges are expensive. Among the most successful hedge fund strategies in recent years has been convertible bond arbitrage. Hedge funds buy convertible bonds, which carry a low coupon but can be exchanged for equity at a certain price. They then take short position against the company's stock, trading on the relationship between the company's stock and bond prices.
- a mutual fund that hedges its risk by buying or selling options to protect its position against market risk. For example, a fund specializing in government debt securities may hedge its position by selling call options against its position to protect it against downside risk. Contrary to popular opinion, a hedge fund constructively uses options to protect investment positions and pursues an extremely conservative investment philosophy.
private investment partnership in which the general partner has made a substantial personal investment, and whose offering memorandum allows for the fund to take both long and short positions, use leverage and derivatives, and invest in many markets. Hedge funds often take large risks on speculative strategies.
private investment partnership (for U.S. investors) or an off-shore investment corporation (for non-U.S. or tax-exempt investors) in which the general partner has made a substantial personal investment, and whose offering memorandum allows for the fund to take both long and short positions, use leverage and derivatives, and invest in many markets. Hedge funds often take large risks on speculative strategies, including program trading, swaps, arbitrage, and other market-neutral investing. A fund need not employ all of these tools all of the time; it must merely have them at its disposal. Since hedge funds are not limited to buying securities, they can potentially profit in any market environment, including one with sharply declining prices. Because they move billions of dollars in and out of markets quickly, hedge funds can have a significant impact on the day-to-day trading developments in the stock, bond, and futures markets.
The funds also require substantial minimum investments that can make it hard even for accredited investors to ante up. Minimums typically range from about $250,000 to $10 million. An investor gives up liquidity in hedge funds. They typically have a one-year lock-up for first-time investors. Since 2000, some mutual fund families and mainstream financial services firms have begun offering hedge funds aimed at the semi-affluent retail market, some with minimum investment requirements as low as $25,000. These are offered as open-end mutual funds or funds-of-funds and as such innovative products as closed-end funds that do not trade on exchanges, and usually offer investors the opportunity to sell shares only quarterly or annually. New rules adopted December 2, 2004, amending the Investment Advisers Act of 1940 require hedge fund managers to register as advisers with the Securities and Exchange Commission (SEC).
