Hedge Funds and Their Advantages and Disadvantages

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Investing in hedge funds is possibly one of the most debated topics among investors. Is it wise to invest in it or are we better off steering away from it?

hedge funds written on a card held by a man in suit


For the supporters of hedge fund investing, hedge funds are an important addition to their lists. Quite obviously, hedge fund critics have some negative views about it.

In this article, we will talk about the advantages of hedge funds as well as their disadvantages. Check them out and learn more about hedge funds.

Advantages

Reduce Losses

One of the main benefits of investing of hedge funds is their ability to lower down the expenses during stock market crashes.

History has shown that hedge funds can prevent heavy losses from troubling investors even when the whole market is down. This improvement in downside protections is a crucial part of improving a portfolio’s risk-return profile. It has been seen repeatedly that hedge funds have been successful at minimizing losses during market selloffs.

Capital Protection

Hedge funds managers consider risks in terms of capital loss. Therefore, they try their best to actively manage risks in order to put a stop to potential losses.

A traditional fund manager, on the other hand, normally considers about risks in terms of performance deviation from an index or benchmark. During difficult times, they usually lose just as much as the market does.

Diversification

By lowering the exposure to the general market movements, as well as only targeting specific risks, a hedge fund can produce a return stream that has a low level of correlation with the general risk assets like equities. They also have a lower level of downside volatility than other generally risky assets.

This has a very crucial role in portfolio construction. If done very well, this can result to a more consistent return profile in a diversified portfolio.

Disadvantages

It is very important to mention the potential hurdles to success when you’re investing in hedge funds. That’s because these disadvantages have huge effects on your returns and portfolio.

Fees and Commissions

The high fees charged by hedge funds are usually cited  as  a huge reason not to invest in them. Sometimes, the risk-adjusted returns after the fees are not even considered.

However, it should be noted that we need to consider the relationship between the fees paid and the value added by traditional investment managers.

Liquidity

There are two aspects of liquidity that should be considered. The first is the liquidity that is offered through a fund’s normal redemption cycle. The second one, which is considered to be more problematic, is the capability or willingness of a fund to abide by its normal redemption terms in bearish or dramatic environment.

Transparency

Portfolio transparency can be considered on a number of different levels. However, the key for most investors is the need to comprehend how the fund’s portfolio is constructed and what it has.

Conclusion

Investing in hedge funds is a very good investment decision, if everything is considered carefully. You should also consider other types of mutual funds that can potentially improve your chances of beating the market.


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