INVESTING 101: CRYPTOCURRENCY HEDGE FUNDS
In one of our earlier posts, we explored what hedging is and how you can take advantage of it as a crypto trader. To recap, hedging simply is the trading of a financial asset to counteract the effect of another trade. Basically, it involves the strategic trading multiple assets in relation to each other to ensure the healthy development of the trading portfolio. Bearing that in mind, it makes it more intriguing to figure out what hedge funds are and how they function. It is a term that comes up rather frequently in Bitcoin and cryptocurrency news and reports, and that is why it is the subject of this piece.
WHAT ARE HEDGE FUNDS?
Hedge Funds are investment projects that make use of complex analyses and investment strategies to make profits and manage risk. Initially, hedge funds focused on minimizing risk by hedging; hence the name. However, the focus has recently shifted from minimizing risk to maximizing profits. Their capital is usually accrued from a several individual investors and firms, and returns are usually allotted to each according to his contribution to the fund; much like how mining pools and betting pools work. By their very nature, hedge funds invest mainly in alternative assets i.e. all asset classes apart from stocks, bonds, and cash. Some cryptocurrency hedge funds are Grayscale, Pantera Capital, Bitcoin Reserve, amongst others.
HOW DO HEDGE FUNDS WORK?
Hedge funds usually employ very aggressive and risky strategies to maximize profits, typically necessitating a high risk — high return model of operation. It is typical a hedge fund pitches a preferred investment strategy to its investors, but it is very flexible by nature. Hence, the fund managers could employ several different spontaneous strategies to profit. Thus, a lot depends on the fund manager/managers’ analytical and discernment skills to make the right moves in the market. Hedge funds can employ strategies ranging from exploiting spread inefficiencies in markets, shorting and trading with high leverage, down to manipulation of fund volatility through activism.
Hedge fund investors are usually very high profile investors, firms, etc; so high profile that investors that do not meet a particular standard of wealth are not usually allowed in. This is usually because it bears a high risk; and investors do not get anything back from the hedge fund until a particular timeframe, lasting up to years, has lapsed. Thus, the preference would be for investors that can bear the risk and the wait. Apart from the investment itself, the investors also have to pay a particular fee. The fee is usually measured in the 2–20 rule, which means 2% of the initial investment and 20% of the profit that exceeds a set amount.
DIFFERENCES BETWEEN HEDGE FUNDS AND OTHER RELATED INSTITUTIONS
· HEDGE FUNDS AND MUTUAL INVESTMENT FUNDS: Mutual investment funds are very similar institutions to hedge funds, and they work almost the same way. The main differences are the target assets and the subsequent degree of regulation they are subjected to. Mutual funds are geared towards stocks, bonds, and cash; the primary classes of assets, and face stricter regulations as a result. Hedge funds, on the other hand, are focused on alternative assets; asset classes apart from the primary ones, and face laxer regulations which allow for greater freedom and flexibility.
· HEDGE FUNDS AND POOLS: Pools are institutions that accrue capital from several investors to make profits. There are several types of pools, such as mining and betting pools. The main difference between pools and hedge funds are down to the specifics. Hedge funds are likely to have loftier requirements for their investors than pools, they are likelier to be under more regulatory scrutiny, and their target assets are peculiar to them. Hedge funds are also famous for their radical strategies and portfolio diversification.
· HEDGE FUNDS AND MLM SCHEMES: Multilevel Marketing Schemes, also known as Ponzi Schemes, are fraudulent investment programs that use funds from later investors to pay earlier investors. These schemes usually take up investment fund tags and sell targets similar to hedge funds and mutual funds, but it is usually a front for earlier investors to bail out while later investors suffer heavy losses.
CONCLUSION
Conclusively, can you invest in a hedge fund? Probably not. They usually have very lofty requirements for investors, requiring a net worth that could run into millions, or a minimum maintenance bank balance running into hundreds of thousands. However, there is an indirect method smaller investors use to buy into hedge funds, known as a “fund of funds”; an investment fund for many small investors which in turn pools the cumulative capital together to invest in a real hedge fund. Should you invest in a hedge fund? You could do so directly or indirectly, if you can bear the cost and the risk. Of course investing in a hedge fund comes with its own benefits; such as having a trained professional manage your investment, having a vast array of powerful investment strategies work for you, etc. However, it still bears a lot of risk, it could take a lot of time before you get access to your funds, and the success of your investment depends on the astuteness of your hedge fund manager. So, the choice is yours.