Understand hedge funds before investing
Hedge funds are an alternative investment style that gained mainstream acceptance after the last sharemarket downturn. However, there is still a lack of knowledge among investors about just what hedge funds are and what value they have in an investment portfolio.Hedge funds rely on unconventional and often complex market trading strategies to try and generate returns in a way that doesn''t follow the normal up and down investment cycles. This means they have the potential to produce higher returns in down markets but may produce lower returns in boom markets. Because of this low correlation to normal market movements, hedge funds can be used as part of a wider portfolio of conventional share, property and fixed-interest investments to smooth out the volatility of overall returns from year to year. But this does not mean hedge funds are non-volatile in themselves - many certainly can be. It''s just that their volatile performance is unlikely to correspond with movements in conventional asset classes. For this reason, fund-of-hedge fund offerings - funds that consist of investments in a range of specialist hedge funds - are often recommended for the average investor for greater diversification. Many super fund and retail fund managers are incorporating allocations to hedge funds into their balanced funds alongside shares and fixed interest. A lowering of the minimum investment required to around $5,000 for some funds has further fuelled the increasing demand for hedge funds among small investors. Some specialist hedge fund managers insist on keeping their strategies and portfolios secret because they say making these public would directly affect their success. A number of strategies that may be used by hedge fund managers include: 1. Global Asset Allocation
Involves the use of research to exploit movements in different industry sectors, currencies and stockmarkets. This strategy tends to be highly geared and uses derivatives. 2. Event Driven
Involves taking advantage of event *or* transaction specific situations. eg mergers, distressed debt, natural disasters. 3. Relative Value
Exploits temporary arbitrage opportunities eg where there are price differences in the shares of one company listed in two different markets. 4. Equity Hedge
Equity hedge managers buy undervalued securities and short sell overvalued securities. 5. Short Selling
Short sellers borrow, then sell, overvalued shares anticipating a decline whereupon the shares are bought back.
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