As you have probably heard, Pippa Middleton is marrying the hedge fund manager James Matthews. It seems the Duchess of Cambridge might have a chance for revenge for that dress.
This morning on the breakfast show on BBC Hereford and Worcester, Elliot Webb and Toni McDonald were asking what a ‘hedge fund’ actually is. Well, we got interested ourselves. So, here we go, an attempt for a simple explanation of hedge funds.
A quick overview for those with little time
As Elliot and Toni themselves said, the clue is in the name. Hedge funds ‘hedge’ risk by investing in a diverse range of financial assets, also known as ‘securities’. They invest both in assets that will have a long-term return, and those which will have a short-term return. The diversity of the investments, theoretically, reduces the level of risk for investors. It’s no different to the way groups such as Spirit Ventures – or household names such as General Electric – operate a variety of different businesses just in case a market downturn affects one of them.
More detail for those with more time
The ‘hedging’ refers to long-short strategies. Like most other investors, they “buy low, sell high” with shares. However, they also sell stock with borrowed money, and buy them back later when the price has fallen. Many also invest in ‘derivatives’, which are essentially contracts to buy a security at a specified price. Hedge funds are also known for their use of ‘leverage’, which is investing with borrowed money. This increases the potential return, but also the potential risk.
Hedge funds are distinct from things like private equity firms because they’re only available to people with significant assets or lots of investment experience. This means they are regulated much less than other financial institutions. The level of regulation has increased since the 2008 crash, and more may yet come. This lack of regulation compared to other institutions means they can invest more widely and use more complex and sophisticated investment techniques. The value of their investments is not valued every day, unlike mutual funds. Hedge fund investors are instead stuck for a ‘lockup period’.
That’s a really quick overview from people who are very much non-experts. But hopefully that helped writing it for people who also don’t know a lot about it! Those who can shed more light on the subject are welcome to comment here on the blog, or on our LinkedIn, Twitter or Facebook accounts.