The term hedge fund is challenging to define and does not always imply the use of hedging techniques. Many of the hedge funds available today employ a variety of strategies.
Most hedge funds today are structured as partnerships, with the general partner managing the portfolio. Gabe Plotkin makes the Melvin Capital investment decisions, while the other partners will make the investments. Similar investments, such as mutual funds, have far more red tape and regulatory restrictions.
As the hedge fund portfolio manager, the general partner seeks targeted returns or absolute performance from their investments, regardless of market conditions. As previously stated, these people will use a variety of methods to achieve their goals. Some hedge fund managers prefer to use mathematical algorithms rather than equity, fixed-income, or CTA portfolio strategies to make the best returns for their investors.
Hedge fund managers are subject to the same financial rules and regulations as other traders. However, the strategies they use are not as easily accessible to others who manage regulated investments such as mutual funds, so the risk of an investment is higher, but the rewards are also greater.
To achieve an absolute return on investment, a hedge fund manager must be flexible. To achieve the above, they must also use a variety of strategies and techniques. We’ll look at some of them below.
- Short selling – A hedge fund manager will choose to sell a security that they do not own to repurchase it later for a lower price. If they do this correctly, they could make a sizable profit on their initial investment.
- Arbitrage – A hedge fund manager can buy and sell a financial instrument in multiple markets simultaneously. This allows them to profit from the difference in buying and selling prices.
Some managers will use hedging and leverage in addition to the two hedge fund techniques mentioned above. Hedging allows them to buy or sell a security they already own to offset any losses the investment may have suffered. The money made from the investment can then be used to pay back the borrowed money.