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Business News/ Money / Personal-finance/  Dejargoned: Hedge fund: a complex product, works only for HNIs
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Dejargoned: Hedge fund: a complex product, works only for HNIs

Hedge funds use strategies far more complex than a typical mutual fund, which mostly focuses on generating returns within one asset class or through simple asset allocation

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Still at a nascent stage in the Indian market, hedge funds are popular overseas. They are known for their promise to generate absolute returns by buying market-linked securities. Given the volatility in global markets, their popularity has increased as they do not conform to any specific strategy. The word ‘hedge’ means to protect. Hedge funds promise to protect returns by investing in multiple strategies and assets, and aim to generate a positive absolute return.

How does it work?

Hedge funds are similar to mutual funds as they pool together investors’ money. This is then invested as per the funds mandate and returns are distributed among unit holders. But the similarity ends there. Hedge funds use strategies far more complex than a typical fund, which mostly focuses on generating returns within one asset class or through simple asset allocation. Hedge funds will go for buying-selling derivatives, equity, currency, commodities, leverage; anything to give absolute returns with minimum risk. They depend on statistical tools and models to build portfolios, rather than on fundamental research for security selection.

These funds are managed very actively and there could be many transactions in a day. The idea is to invest where the near-term opportunity is and take profit before that opportunity fizzles out.

Hedge funds seek to minimise risk. However, given that there is leverage involved in may of them, the risk can get amplified when there is uncertainty or nervousness in the financial markets.

Benefits and Risks

It is meant for sophisticated investors. In India, these funds are governed as a Category III product under the Alternate Investment Fund Guidelines issued by the Securities and exchange board of India (Sebi). These rules specify a minimum investment of Rs1 crore from every investor.

It is a good for diversification, but also very complex and should be used only by high net worth individuals, who understand its nuances.

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Published: 29 Sep 2016, 04:15 PM IST
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