Purpose of Hedge Funds

Many hedge funds actively pursue a strategy that allows them to generate positive (sometimes fantastic!) returns during both rising and falling equity and bond markets. The objective of any decent investment manager is to reduce the portfolio risk and volatility (variability) while simultaneously increasing returns. Many hedge funds deliver returns which are not market-correlated, meaning, they still earn returns whether the market is going up or sliding down. Many sophisticated investors go to hedge funds primarily because of their consistency of returns and its preservation of capital (safety) rather than the magnitude of returns.

Man since the earliest times has tried to control his destiny by trying to look into the future. A hedge fund is likewise an attempt to control that unforeseeable economic future by minimizing market risks through hedging and therefore maximize return on the investments. When talking of returns, we must distinguish between the two concepts of relative return and absolute return. Some fund managers would be happy if they lost only 10% of their value while the broad overall market lost 25% of its total value. This is an example of the concept of relative return. In the case of hedge fund managers, they have to deal with the concept of absolute returns. In the example above, a hedge fund manager is often expected to produce a positive return ranging from 10%-35% during the same period. Even this sterling performance by the hedge fund manager can be considered a letdown if other competitor hedge funds produced returns of 40% upwards over the same time frame. A hedge fund manager is therefore expected to produce positive returns year in and year out. Investors in hedge funds are hard task masters indeed! Those who under perform will see a lot of fund redemptions.


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