Optimizing Returns with Hedge Funds
Hedge funds have a questionable reputation. This is a mistake. In times of low volatility, they are considered to be superior to other securities when it comes to returns. Investors also willingly invest in hedge funds for risk diversification.
Will share prices continue to rise? Or will a correction on the stock exchange soon follow? Financial specialists say that both scenarios are just as likely. Financial market volatility has not been this low for a long time. These low fluctuations suggest low risk. The monetary policy of the central banks has made a significant contribution to the low volatility. However, this effect is likely to fade gradually.
It is a tricky situation for investors. Should you buy equities now or sell existing positions at a good price? Only one thing is certain: Having cash in an account is not profitable with the low interest currently being paid. Then what should investors invest in?
One option is to put money into hedge funds. They are less dependent on market development than equities, for example. Not only can hedge fund managers buy or sell securities, they can also generate profits using a variety of different strategies. This way they can generate returns themselves, even when stock prices are flat or falling. Hedge funds are therefore more promising in directionless markets than other investments. They also help to improve the risk/return profile of the overall portfolio.
Two Hedge Fund Strategies for More Return in Directionless Markets
The Relative Value Strategy
As the name suggests, this strategy conforms to the relative value of a financial investment. Some securities are traded on different financial markets. But the price is not always the same. With the relative value strategy, hedge fund managers look for price differences in the stock market. They buy underpriced securities in a financial market and sell them at a higher price everywhere else. The price difference is provided to the hedge fund as a profit.
The long/short strategy for equities
Long or short refers to buying or selling positions, respectively. Long is for the buyer, while short is for the seller. On one hand, when it comes to the long/short strategy for equities, hedge fund managers buy securities that they hope will increase in value. They then sell these at a higher price. On the other hand, they place short sales of equities that they deem to be overvalued. With these short sales, hedge fund managers do not own the securities yet. They borrow these and speculate that they will be able to buy these cheaper at a later time and give them back them to the lender. If the strategy is successful, it will result in a profit.
Hedge against price losses with hedge funds
Hedge funds are not just suitable for investors that want to improve their return potential. They can also be an appropriate means for people who would like to set up their portfolio to be more robust for tumultuous times. This way, they can support the portfolio up to a certain point so that they will be less dependent on stock market trends.
Despite these advantages, hedge funds are despised by many investors. Some hedge funds have posted high losses in the financial crisis and partially suspended withdrawals. But times have changed. The industry has transformed itself over the past decade. The transparency and regulation of funds has risen sharply. Many hedge funds are now domiciled in regulated markets. Investor-friendly standards, such as valuation and custody of assets by independent parties, have long been established.
Risk versus return when investing money
Of course, it is still imperative that you carefully examine the risks of hedge funds before investing in them and only make purchases through a reputable partner so that you can protect yourself against "black sheep." The funds should be continuously monitored even after purchasing them.
In terms of return and risks, investors must be aware that there are hedge funds with various risk profiles – from low to high risk with corresponding return expectations. The risk of investment money can be reduced by scattering or diversifying investments. Like equities, hedge funds are a long-term investment: They can only carry out their strategic function in the portfolio when they have been held for a longer time.