What Are Hedge Funds?

With Strategies Designed to Produce Positive Absolute Returns, hedge funds have become attractive members of the investment world. However, hedge funds carry the same investment risks as traditional investments, so it’s crucial to know your way around hedge funds to avoid making a big investment mistake.

Hedge funds are similar to mutual funds in that they consist of funds pooled by a collection of investors, and fund managers make money on the stock market using a specific investment strategy. However, unlike mutual funds, Hedge Funds don’t attempt to produce relative returns by outperforming market indexes; they seek positive absolute returns, regardless of how the overall market is performing. While mutual funds engage only in long positions, hedge funds employ speculative strategies, such as short selling and derivatives trading.

Hedge funds are aggressive, engaging in many active investment strategies to maintain a constant profit. In the long/short hedge fund strategy, short positions offset potential losses if the market declines, while long positions yield profits if the market trends up. Arbitrage hedge funds tend to engage in straight forward price exploitation strategies, such as purchasing a futures contract when current prices are low, translating to an immediate profit. These hedge funds are considered to be fairly low-risk, comparatively speaking, but they are not risk-free, and their low-risk approach means only moderate returns.

One of the more aggressive hedge fund strategies monitors current events that are likely to affect the Marketplace. Managers for these hedge funds may react to an acquisition, a distressed company or small, inefficiently organized companies. Hedge funds may buy up shares of a company in anticipation of marketplace reaction, or they may buy a large chunk of ownership in a small company and use the position to force changes. These hedge funds are difficult to predict, and their agenda may not always be transparent.

Since Hedge Funds aim for a positive return in all conditions, that ambitious goal comes at a price. To get into a hedge fund, you need to be willing to invest a high amount up front, sometimes as much as $1 million. There are hedge funds for investors who don’t have as much cash on hand, and funds of hedge funds are also an option, but many hedge funds are for big-league investors only. Then, once you are in, many hedge funds charge a high 2% percent fee and 20% percent of profits, so, even if you enjoy a good return on a hedge fund, not all the money will find its way into your pocket.

Hedge Funds and The Bear Market

While mutual funds may outperform hedge funds in a Bull Market, hedge funds are a popular investing strategy in a Bear Market. Because hedge funds focus on absolute positive performance, successful hedge funds may be one of the few ways to show a profit during a bear market. For example, hedge funds that engage in long/short strategies may be better insulated from overall market performance. But they’re still a risky investment, so keep hedge fund risk management in mind when you’re shopping around for a bear market investment vehicle.

Funds of Hedge Funds

Because hedge funds themselves are subject to volatility depending on market conditions and Investment Strategies, investing in funds of hedge funds has become a way to offset some of that volatility. With funds of hedge funds, investors come together to invest in a pool of hedge funds—anywhere from a few funds to dozens of hedge funds. By investing in many hedge funds instead of a single fund, investors minimize volatility and risk through diversification. However, if funds of hedge funds invest in too many hedge funds, performance is likely to be comparable to overall market performance, and that defeats the purpose of investing in hedge funds.

When looking at funds of hedge funds, be aware that these funds are basically subject to a double fee structure. The underlying hedge funds charge a management fee and a portion of the profits to every investor, including investors from funds of hedge funds. You then have to pay the fund of the hedge fund’s management fees and any profit sharing—which are already high—so you’re basically paying fees twice.

The Risks of Hedge Funds

Hedge Funds are lauded as a sound investment strategy even during a bear market, but the reality is that hedge funds carry just as much risk as any other investment vehicle. While many hedge funds have traditionally turned modest profits even in times of market decline, the 2008 economic issues and stock market volatility made a drastic impact in Hedge Fund performance. Some hedge funds showed a loss of over 17% in 2008, and, while that number isn’t necessarily out of proportion to overall market performance, it’s a far cry from the modest profits that hedge funds boast even in a bear market.

To Practice Effective Hedge Fund Risk Management, look for funds whose investment style is relatively low-risk. Overly aggressive hedge funds that engage in risky market strategies are more likely to cause investment losses. Because hedge funds are pools of private investors, hedge fund regulation is pretty much nonexistent. Hedge funds are not required to report to the Securities Exchange Commission (SEC) or produce any of the normal performance-related documentation required from other investments. You may not be able to get an accurate idea of hedge fund performance, and some hedge funds are reluctant to reveal fee structures and investment strategies. This is one area in which funds of hedge funds are beneficial; like mutual funds, many funds of hedge funds are registered with the SEC and provide investors with an annual prospectus and quarterly reports.

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Stock Market: What Are Mutual Funds?

­A Mutual Fund is a company that pools investors' money to make multiple types of investments, known as the portfolio. Stocks, bonds, and Money Market Funds are all examples of the types of investments that may make up a mutual fund.

The Mutual Fund is managed by a professional investment manager who buys and sells securities for the most effective growth of the fund. As a mutual fund investor, you become a "Share Holder" of the mutual fund company. When there are profits you will earn dividends. When there are losses, your shares will decrease in value.

­Mutual Funds are, by definition, diversified, meaning they are made up a lot of different investments. That tends to lower your risk (avoiding the old "all of your eggs in one basket" problem).

Because someone else manages them, you don't have to worry about diversifying individual investments yourself or doing your own record keeping. That makes it easier to just buy them and forget about them. That's not always the best strategy, however -- your money is in someone else's hands, after all.

Since the fund manager's compensation is based on how well the fund performs, you can be assured they will work diligently to make sure the fund performs well. Managing their fund is their full-time job!

Mutual Funds can be open-ended or closed-ended. But many people consider all Mutual Funds to be open-ended, while putting closed-ended funds in another category.

"Open-Ended" means that shares are issued in the fund (or sold back to the fund) whenever anyone wants them. With closed-ended funds, only a certain number of shares can be issued for a particular fund, and they can only be sold back to the fund when the fund itself terminates. (You can sell closed-ended funds to other investors on the secondary market, though.)

Load refers to the sales charges added to a mutual fund when you purchase it. The load charge goes to the fund salesperson as a commission and payment for their research services. Load charges can be up to 8.5% percent of the selling price and can be figured in as a front-end load (meaning you pay it when you buy the mutual fund) or a back-end load (meaning you pay when you sell the mutual fund).

Many Mutual Funds are no-load funds. Yes, that means there is no sales fee charged and the fund is direct-marketed so you can buy it without the help of a salesperson. With the wealth of information on the Internet today, it is certainly easier to make smart choices yourself to save money.

In addition to "No-Load Funds", there are also funds that charge up to 3.5% percent as a sales fee. These are called low-load funds and can still be a good deal.

Mutual Funds Fall Into Three Categories:

Equity Funds - are made up of investments of only common stock. These can be riskier (and earn more money) than other types.

Fixed-Income Funds - are made up of government and corporate securities that provide a fixed return and are usually low risk.

Balanced Funds - combine both stocks and bonds in the investment pool and offer a moderate to low risk. While low risk may sound good, it is also accompanied by lower rates of return-meaning you risk less, but your investment won't earn as much. You have to decide how much risk you're willing to take on before you invest your money.

If you have invested in a College Savings Fund (529 Plans - ­Next to saving for retirement, your biggest financial challenge is probably saving for your kids' college education.) or a 401k Account (In 1978, Congress decided that Americans needed a bit of encouragement to save more money for retirement! The plan got its name from its section number and paragraph in the Internal Revenue Code - section 401, paragraph K), chances are good that already own a few Mutual Funds. Mutual Funds are great for long-term investments like these. You can also buy mutual funds directly from a mutual fund company.

Most of these offer 'No-Load Funds' (or sometimes low-load funds). You can find lists of mutual fund companies on the Internet and purchase shares by simply filling out an application and mailing a check. Once you are a shareholder, you will receive statements telling you how the fund is doing as well as how much your own investment is growing. You can also set up monthly bank transfers to automatically buy more shares every month.

Remember to do your research and select a Mutual Fund that fits the level of risk you are willing to take with your hard-earned cash. Then just sit back and hope for the best!

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Introduction to Commodities and Futures: What are Commodities?

The terms “Commodities” and “Futures” are often used to describe commodity trading or futures trading. You can think of them as generic terms to describe the markets. It is similar to the way “Stocks” and “Equities” are used when investors talk about the stock market. To be more specific, this is what they really mean: Commodities are the actual physical goods like Corn, Soybeans, Gold, Crude Oil, etc. Futures are contracts of commodities that are traded at a futures exchange like the Chicago Board of Trade (CBOT). Futures contracts have expanded beyond just commodities; now there are futures contracts on financial markets like the S&P 500, T-notes, Currencies and many others.

Examples:

Commodity: Grains

Many of the grain commodities have been trading on futures exchanges have been around many decades and they are some of the most active markets to Trade. They tend to be most volatile during the summer months as whether can be a big market mover.

1. Corn
2. Soybeans
3. Wheat

Commodity: Energy

Used to power and fuel the country, the energy commodities are very popular futures markets to trade as many witness their uses and prices daily.

1. Crude oil
2. Gasoline
3. Heating oil
4. Natural gas

Commodity: Metals

The metal commodities maintain a couple of roles. The precious metals are used as an inflation hedge. They are also used for industrial purposes, construction and even photography.

1. Gold
2. Silver
3. Copper

Commodity: Softs

The soft commodities consist of many food products and also some industrial materials.

1. Coffee
2. Cocoa
3. Sugar
4. Cotton

Commodity: Livestock

The livestock commodities consist of meat agricultural products. They can often develop some reliable trending patterns as breeding and herd statistics give you a good idea of production numbers months in advance.

1. Cattle
2. Hogs

Futures Contract:

December 2007 Corn, which is a contract of 5,000 bushels of corn that trades at the Chicago Board of Trade with a contract expiring in December 2007. A hypothetical price for this contract might be $3.60 per bushel.

How do Futures Work?

Futures are standardized contracts among buyers and sellers of commodities that specify the amount of a commodity, grade / quality and delivery location. Commodity Trading with futures contracts takes place at a futures exchange and, like the stock market, is entirely anonymous.

For Example: the buyer might be an end-user like Kellogg’s. They need to buy corn to make cereal. The seller would most likely be a farmer, who needs to sell his corn crop. They create a contract of December Corn futures at the current market price. A contract of corn at the CBOT consists of 5,000 bushels. Therefore, the farmer would have to deliver 5,000 bushels of corn to Kellogg’s in December at a designated location.

Making Money in Futures!

A speculator is someone who invests in a business with the goal of turning a profit. In the case of commodities, speculators are traders who try to buy futures low and sell them high to Make Money. The reason why speculators can do so with futures is that traders aren’t required to hold the futures contracts for the duration of the contract; they can buy or sell anytime they want. So, to use the Kellogg’s example above, a speculator could buy the corn contract from the farmer at a certain price, then wait for the price of corn to go up before selling the contract to Kellogg’s, even if the contract won’t come due for another couple of months, turning a Profit in the process.

Players Involved in Commodities Trading!

There are three different types of players in the commodity markets:

Commercials: The entities involved in the production, processing or merchandising of a commodity. For example, both the corn farmer and Kellogg’s from the example above are commercials. Commercials account for most of the trading in commodity markets.
Large Speculators: A group of investors that pool their money together to reduce risk and increase gain. Like mutual funds in the stock market, large speculators have money managers that make investment decisions for the investors as a whole.
Small Speculators: Individual commodity traders who trade on their own accounts or through a commodity broker. Both small and large speculators are known for their ability to shake up the commodities market.

How to Start Trading Commodities?

In Order to Trade Commodities, you should educate yourself on the futures contract specifications for each commodity and of course learn about trading strategies. Commodities have the same premise as any other investment – you want to buy low and sell high. The difference with Commodities is that they are highly leveraged and they trade in contract sizes instead of shares. Remember that you can buy and sell positions whenever the markets are open, so rest assured that you don’t have to take delivery of a truckload of soybeans.




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