Modern Hedge Funds - Essay Example

Modern Hedge Funds Introduction Hedge funds have for a long period been in the business to support different investments and they aim at achieving positive business growth rates using their different investment techniques. Many hedge fund managers always try to exploit several lending techniques that are available in the market. This ensures that they are at least guaranteed of their funds through the security; thus, their money remains safe even in other people’s investments. This study shall discuss the interpretations held in the statement that modern hedge funds are no longer capable of successfully reducing risk and that they now struggle to provide absolute returns to investors (Lo, 2010: 120-129). Discussions of hedge funds Modern hedge funds use certain investment techniques that are different from those of traditional ones so as to reduce the risk percentage and ensure that they provide what their investors require. These techniques include short selling, arbitrage, hedging and leveraging. Short selling involves selling of the borrowed securities in case the money is not refunded accordingly for a profit at a cheaper price. Arbitrage, on the other hand, is achieved by looking for low risks in the market by exploiting the inefficiencies between the business and the security thus, ensuring a good flow of the hedge funds and their payment. Hedging is involved with the purchase of insurance of the funds against unfavourable events in the market, currency and interest rate from any risk. Leveraging focuses on the creation of a portfolio that gives out clear indication of the base capital and overall assets so that as the funds are allocated they will be according to the actual investment value. Hedge funds are also categorised so that as the investors come to borrow money they will be classified to a certain category in which its terms and conditions will apply accordingly. Such include short sellers, equity short/long, event driven, global asset allocators and relative value categories. This categorisation simplifies the process of allocating funds to different investors and reduces the time duration to get the funds because faster processing is enhanced. Most people term the world of hedge funds as a collapsing one which is not the case although it suffered huge losses especially in the financial year 2008 when they incurred a loss of 20% but, the recovery was swift. Hedge fund world is relatively small compared to other significant pools of wealth and it is a huge effort that they are able to manoeuvre their way up in the capital market despite the many challenges encountered. This has also improved through the fact that hedge funds are no longer funded by private funds through private banks. Since the pension fund made an allocation to hedge funds, there has been a great improvement in their performance and financial status because they no longer suffer huge losses like before. While investors fear risking their money and want to learn through experience first, hedge funds risk the money and at the end investors will have the money as hedge fund get the feel (Scaramucci, 2012). Hedge funds have grown from relative to absolute returns with the current trend of lending by creating portfolios that have low compound returns but with high probability and volatility that have enabled them reduce risks of loosing their money in the investment taking centre stage. Current hedge funds have an aim of exploiting investment opportunities that are available rather than hitting the market index because this will keep them alive in the business while they still earn their profits from their investments. There are those who believe that relative returns on hedge funds are a high risk to investment because the manager is not responsible for the client’s money, but this is not the case. Any project that is undertaken is usually done to better the investment opportunity because that is also the means by which they raise their money and profits and, therefore, will be keen not to incur losses (Gregoriou, Karavas & Rouah, 2003). Hedge funds help in reducing risks involved in an investment by forcing investors to think outside the benchmark and view the investment funded from a different perspective that will be able to earn the required returns as expected. The reason as to why hedge funds have opted to provide absolute returns to the investors is because they want them to consider the investment not just like a risk but, also as an item that is existing thus, will do anything possible to overcome the risks. Through such exposures, the investors will be entitled to the asset class directly when going up and down too, and a person should ensure that they work extra hard to avoid any form of a fall. Hedge funds have greatly improved their risk management skills by creating awareness and training of the investors on the skills and experience so that with time it develops from them. The urge came about because of having investment opportunities that are very valid, but the investors barely knowing what they involve themselves into in case of risk and how they can manage that so as not to have a downfall of their business ventures (Nicholas, 2005). They seek and exploit opportunities and try their best to do what is within their means to control the risks involved. There are so many speculations that have been brought forth about hedge funds in an attempt to scrape them out of the market and make way for their competitors. For instance, hedge funders are said to be gamblers but, this is not true because they are not a casino; it is just that their investments depend on luck and not the founder of the hedge fund (Hammer, 2005). When returns of any entrepreneur become stable and sustainable, they become very predictable which is not good for investment. One must be exposed to some level of risk so as to put more effort to the investment and avoid taking chances; therefore, will try their best in whatever it is that they are doing. Hedge funds’ returns are a function of taking risk and if an investor does not take it the business might as well not be safe. They do not always hedge because there are returns despite the risks involved. If hedge funders always hedge the investors will only have total losses in what they invest. The difference between hedge funds and traditional portfolios is that, the latter does not expect to be compensated while the former wants both the fund and the investment to be involved, and fully committed to the investment being funded; therefore, will be willing to share the profits and losses. Some hedge funds deliver consistent returns to investors with lower risk management while others like long equity are dependent on directions of the currency and interest rates (Lo, 2010.p.110-114). Considering that hedge funds are risky investors will not put all the investment into a single portfolio but, will try to diversify it to avoid total risks or loss of the invested funds. Hedge funds are likely to create a balanced portfolio to their investors unlike in many lending organizations, by discouraging their investors from putting on their investment in a single portfolio. Hedge funds use speculative financial statements because they are used as hedges to create portfolios as the managers consider them more conservative than relative returns. The fact that it is the manager that decides about the risks and says whether it is a risk or not does not make absolute returns speculative; rather it makes them conservative. All hedge funds are said to charge high fees because of the headlines that hit the news of how many millions they take home yearly. This is their awarded effort and if it is broken down into the real and actual cost and time used in creating and selling portfolios people will be surprised and get the facts (Agarwal & Naik, 2005). If the figures are explained to the public or people take the time to read and understand them, they will see that lot of efforts are needed as is put in by the managers. Subsequently, the stressing things they deal with together with losses that they incur while still at it will be revealed. Hedge funds have been said to have the capabilities to generate strong returns in all market conditions. However, this is not true because not all business environments favour hedge funds but their consistency to their investments (Logue, 2011.p.154-163). Most of them have greatly suffered losses at some point in their running, but persistence and belief in their business ventures have kept them going. Their whims are always laid out in the stock market thus; speculations about them being favoured by the market trends should be stopped. Madoff fraud is said to have resulted from a hedge fund scandal which is not the case; it was a dealer that highly damaged the hedge fund industry and so many of them lost their money while others went down completely. Hedge funds are believed to increase systemic risk of financial market that is a myth because they do not force selling it is usually voluntary unless in a case where the investor wants to liquidate, in a rush (Wilson, 2010: 145-152). Conclusion To state that hedge funds are not capable anymore of successfully reducing risks, would be unfair given that they are currently doing the best they can and have improved from their past state of instability. Investors are given can be afforded and the use of absolute return providence helps in bettering the quality of offers. The available fund lenders in the business have their different terms and conditions which also do not totally take risks on behalf of the investors. Hedge funds play their role in the funding market by showing investors the importance of diversified portfolios so that their investments are safe. References List Agarwal, V., & Naik, N. Y. (2005). Hedge funds. Boston, NOW. Gregoriou, G. N., Karavas, V. N., & Rouah, F. (2003). Hedge funds: strategies, risk assessment, and returns. Washington, DC, Beard Books. Hammer, D. L. (2005). U.S. regulation of hedge funds. Chicago, Ill, American Bar Association Section of Business Law. Lo, A. W. (2010). Hedge funds an analytic perspective. Princeton, N.J., Princeton University Press. http://site.ebrary.com/id/10394786. Logue, A. C. (2011). Hedge Funds For Dummies. Hoboken, John Wiley & Sons, Inc. http://www.SLQ.eblib.com.au/patron/FullRecord.aspx?p=275899. Nicholas, J. G. (2005). Investing in Hedge Funds Revised and Updated Edition. New York, John Wiley & Sons. http://public.eblib.com/EBLPublic/PublicView.do?ptiID=241116. Scaramucci, A. (2012). The little book of hedge funds: what you need to know about hedge funds but the managers wont tell you. Hoboken, New Jersey, Wiley. Wilson, R. C. (2010). The hedge fund book a training manual for professionals and capital-raising executives. Hoboken, N.J., John Wiley & Sons. http://site.ebrary.com/id/10484754. Read More