Hedge funds are a relatively uncommon investment vehicle in
India, although the elite across the globe use this extensively
to optimize their portfolio returns. Here's some dope on how these
instruments work and what it could bring to your portfolio in the long run.
Although hedge funds may be alien, `hedging' as a concept is not!—all
thanks to insurance and derivatives which has enabled one to reduce the
downside. Roughly, one can translate `hedging' as
a mechanism to `manage/reduce risk'. This brings us to the obvious next
question of—what are the risks involved and
how are they managed. There are many types of conceivable risks—Market,
Economic—Macro/Micro, Interest Rate, Inflation, Sectoral, Regional, Currency,
etc. Each of these risks can be countered by using various financial
methods—some of these methods being holding
cash, taking derivative positions in any asset class, arbitraging, shorting/short
selling, etc.
A hedge fund is a private investment fund which may invest in a
diverse range of assets and may employ a variety of investment strategies to
maintain a hedged portfolio intended to protect the fund's investors from
downturns in the market while maximizing returns on market upswings.
Mutual funds seek `relative returns', hedge funds typically seek `absolute
returns'. `Hedge Funds' have come to incorporate any absolute return fund, given
their proficiency to chase better returns by investing within the financial
markets (stocks, bonds, commodities, currencies, derivatives, etc.) and/or
applying non-traditional portfolio management techniques including—shorting,
leveraging, arbitrage, swaps, etc.—the intent to provide good returns is
irrespective of how the overall markets pan out.
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