Investment funds: what are hedge funds?

In the stock exchange world, so-called “hedge funds” have been on the rise since the beginning of the twenty-first century. Hedge funds occupy a special place in the world of the stock market and have a reputation among the investing public for being rather vague and abstract. This is partly because hedge funds have and determine their own rules and objectives more than normal investment funds. Moreover, they always count on a high return, even when the stock market is doing poorly. Particularly because of the latter, the operation of these types of investment funds is subject to considerable criticism. What exactly are hedge funds and how do they operate?

What are hedge funds?

Hedge funds are investment funds that try to hedge against a downturn or crisis on the stock market in every possible way. The intention is to maintain a high return, even when the stock market is doing poorly. Hedge funds occupy a special place in the international stock exchange world, as they are subject to fewer regulations than traditional investment funds. Hedge funds pretty much determine their own rules and objectives.

Origin of name “hedge fund”

“Hedge”

The term hedge fund comes from the English word hedge, which literally means: border, boundary of an area or space. In the financial world, the meaning has been expanded to “limitation or delineation of financial risks”. You can therefore regard hedge funds as investment funds that want to hedge themselves as much as possible against unexpected fluctuations in the financial markets.

Defensive?

Hedge funds also aim to anticipate currency fluctuations. The aim is to achieve the highest possible return by limiting financial risks. Hedge funds in themselves are therefore investment funds with a defensive character, since they want to avoid as many risks as possible.

Hedge fund operation

Asset classes

Hedge funds aim to achieve as much return as possible with certain categories of investments. They can invest in all types of categories, such as shares, bonds or certain currencies. The most important category of hedge funds are long/short equity funds.

Shorting stocks

The long/short equity funds buy stocks that they consider undervalued and sell stocks that they believe are overvalued. However, these funds sell those shares without actually owning them, because they borrow the shares from financial institutions. Selling in this way is also called “shorting” .

Criticizing hedge funds

Speculators

In the international stock exchange world, hedge funds have to deal with a lot of criticism. Hedge funds that speculate on falls in the price of shares or currencies can benefit greatly from a stock market crisis. Making a lot of profit while ordinary investors make big losses does not make hedge funds any more popular.

Cost

Critics argue that this way of trading poses a risk to the stability of the entire financial system. Other criticisms include directly or indirectly affecting a company’s shares and the relatively high costs of hedge funds.