What are Hedge Funds?

Hedge Funds India

Hedge funds are still in their early stages and are not as well known as other types of mutual funds. Even though they, too, pool investments from various investors, they employ highly complex strategies to ‘hedge’ risks and give high profits. In this article, we will summarise everything you need to know about hedge funds and trace their rise in popularity in India.

What exactly are Hedge Funds?

To hedge means to secure, and safeguard against risks in the context of investing. A hedge fund invests funds raised from large investors such as banks, insurance companies, High Net-Worth Individuals (HNIs) and families, trust funds, and retirement funds. 

This is why these funds frequently operate as overseas investment companies or private investment partnerships. They are not mandated to register with SEBI, nor are they mandated to disclose their NAV regularly, as are other mutual funds.

Types of investments in a hedge fund portfolio include derivatives, equities, bonds, currencies, and convertible securities. As a result, they are also regarded as different securities. 

They undergo extensive planning because they are a collection of assets that strive to ‘hedge’ risks to investor money against market ups and downs. Unlike traditional equity mutual funds, they frequently use significant leverage. They have long and short positions, as well as positions in both listed and unlisted derivatives.

Who should put money into hedge funds?

Hedge funds are mutual funds that are maintained privately by experts. As a result, they tend to be a little more expensive. As a result, they are only affordable and feasible for the wealthy. You must not only have surplus funds but also be an aggressive risk-taker because the manager buys and sells securities at breakneck speed to keep up with market movement patterns.

As you are aware, the greater the structural complexity, the greater the risks. As a result, hedge funds have a much higher expense ratio (fee to the fund manager) than regular mutual funds. It can range between 15% and 20% of your profits. As a result, we recommend first-time depositors to avoid these funds until they have gained significant experience in the field.

Even so, it is entirely dependent on the fund manager. Investing in hedge funds can thus cause insomnia unless you have complete trust in your fund manager.

What are the Characteristics and Advantages of Hedge Funds?

The hedge fund sector in India is relatively new, with the Securities and Exchange Board of India (SEBI) allowing alternative investment funds in 2012. (AIF). They have the following characteristics:

High-Net-Worth Investors

Hedge funds can only be invested in by qualified or accredited investors. They are mostly wealthy individuals, banks, insurance firms, trust funds, and retirement funds. The required ticket size for these funds for investors is Rs 1 crore.

Portfolio Diversification

Hedge funds invest in a diverse range of assets, including currencies, derivatives, stocks, real estate, equities, and bonds. Yes, they must cover all asset classes; their only limitation is the mandate.

Higher Fees

They are concerned with the expense ratio as well as the management fee. Globally, it is ‘Two and Twenty,’ which means a 2% fixed fee and a 20% cut in profits. The management fee for hedge funds in India can range from 2% to 1%. In general, profit sharing ranges from 10% to 15%

Taxation

Tax pass-through status is still not granted to Category III AIFs (hedge funds). This means that the income generated by these funds is taxable at the investment fund level. 

As a result, the tax obligation will not be passed on to unitholders. This is a major drawback for this industry because they are not on equal footing with other mutual funds.

Conclusion

Hedge funds are only available to high-net-worth individuals. Mutual funds, on the other hand, are available to a large number of people. You can start a SIP with as little as Rs. 500. In short, hedge funds are higher-risk funds that seek higher returns than mutual funds.

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