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11 April 2023 09h20
Source: Banco Carregosa

What are hedge funds and how do they work?

What are hedge funds and how do they work?


A hedge fund offers high net worth investors a unique opportunity to grow their wealth, profit from the ups and downs of the markets, take aggressive positions and entrust their portfolio to some of the world’s most experienced managers. But what exactly are hedge funds, who can invest in them and what benefits – and risks – should you be aware of?  


What are hedge funds?  


In essence, hedge funds work like any other fund: the capital raised from investors is invested to buy assets with the aim of increasing their value over a certain period of time. The big difference is that unlike mutual funds or ETFs, which are openly traded on the stock exchange, hedge funds are close-ended funds. In other words, they are controlled by a limited number of managers and are only open to investors with a minimum amount of capital, ranging from €100,000 to millions of euros. The management team is responsible for all the fund’s decisions, from selecting positions to defining strategy and risk levels, the main objective being aggressive asset growth.   


This difference means that hedge fund managers are not subject to the same restrictions and regulations that apply to other funds. Managers can buy assets that other funds cannot, including real estate, bonds, art, and currencies. Hedge funds are therefore considered high-risk, high-reward investments.   



What are the advantages and risks of hedge funds?  


One of the main advantages of investing in hedge funds is that they can invest in a wide range of assets. They are managed by professionals who receive a share of the returns (in the form of performance fees) and therefore have an additional incentive to ensure that the fund performs well. These funds can use bespoke strategies to generate returns from the equity, bond, property or precious metals markets, whether they are rising or falling. When integrated into a diversified portfolio, hedge fund investments can reduce risk and balance an investor's portfolio.  


However, hedge funds are not recommended for those who are risk-averse or do not fully understand how financial markets work. In fact, the information requirements for participants and the markets are less demanding, to the extent that it is possible for the investor to be unaware of a particular fund’s portfolio.   


In addition, the investor cannot ‘enter’ or ‘exit’ these funds at will. The investment involves a lock-up period during which shares cannot be redeemed or sold. This means that there is a risk of having to wait (sometimes years) or incur additional costs to convert a financial instrument into a liquid asset. Finally, it is important to consider the risk of losing all or part of your investment.  



What precautions should be taken when investing in hedge funds?  


If you are considering investing in hedge funds, there are a number of factors you should be aware of before taking the first step. First, you should have a substantial amount of capital available. The next step is to ensure that your understanding of the risks is clear and consistent with your investment objectives, time horizon and risk tolerance. To do this, you will need to rely on suitably qualified hedge fund managers who have a good track record of delivering returns.   


It is also important to understand the fees involved, as they can greatly affect your returns. You should also make sure that the lock-in period is in line with your expectations. Finally, do not hesitate to ask any questions. Try to meet the management team and ask about the strategy, asset types and time horizon.   



What are the alternatives to hedge funds?  


Hedge funds may not be suitable for investors with a more moderate risk profile. In this case, more conventional investment funds may be considered, such as Exchange Traded Funds (ETFs), which can be traded on the stock exchange in the same way as investing in a company’s shares. In addition, the risks are lower and easier to predict as they are limited to market fluctuations.   


Equity, bond and balanced funds can also be considered. These are slightly riskier, but offer a higher probability of a return. The key is to invest for the long term to cushion the impact of short-term market fluctuations. When it comes to bond funds in particular, the probability of loss is even lower.   



The soundness of Banco Carregosa as protection for your investments 


Every investor, even the most experienced, faces a degree of uncertainty, exacerbated by national and global macroeconomic and political instability. It is therefore essential to rely on the experience of qualified professionals in order to devise a good investment strategy. The team of experts at Banco Carregosa has decades of in-depth market knowledge and is ready to advise you on high-risk financial products. Contact us and benefit from tailor-made strategies to grow and protect your wealth.