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Benefiting every portfolio, hedge funds are able to give strategies to hedge against the risks we face in the market. Everyone needs protection from market meltdowns all the time.
Hedge funds are quite similar to mutual funds. Except, mutual funds do not need a minimal regulation and mutual funds also do not need a minimum investment. The strategies are different between the two though.
An investment in hedge funds is completely up to the manager, they can pretty much do what they want. Whereas, a typical mutual fund manager would for example have an allocation set, maybe 60% stocks and 40% bonds. Whilst a hedge fund manager has more flexible options available to him.
So, let's have a look at the strategies:
Hard assets protect investors from over exposing themselves to equity markets. A hedge fund manager can sell most securities and hold most of the cash if he wishes.
Selling stocks in order to buy them back at a cheaper price is known as shorting or short selling. If you have a margin account, you are welcome to do this. However, as it’s a high risk strategy, a mutual fund manager may be entrusted to do such.
Typically, hedge funds will mix short selling with longer term positions. That’s where the name long-short comes from. They will buy the securities that they believe are about to increase in value, whilst shorting securities that they believe are due to fall.
Exploiting imbalances in values between different securities is a process named as arbitrage investing.
This is a process of seeking an imbalance in a security from the same company who issued it. Investing in both short and long positions, you are actually hedging against the market risk. A manager could possibly go ahead with selling that company’s stock whilst buying bonds from the same issuing company.
Invest cautiously with these different strategies. If ever in a meltdown, these strategies will provide you with a stable return. However, don’t invest any more than 10% of your portfolio.
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