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?
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.
[SEE ALSO: The Importance of Diversification]
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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