What are hedge funds? Free investment funds

Everyone, whether related to investment or not, has heard of hedge funds, also known as hedge funds or alternative investment funds. Thus, the story of how George Soros brought down the pound at the beginning of the 90’s, John Paulson’s incredible bet on the collapse of mortgages in the United States or names like Julian Robertson or Michael Steinhardt are part of the history of the markets. Although not all of them shone, other names of bad memory such as Bernie Madoff or Julian Robertson, who lost billions due to the fall of the Japanese yen triggering a world crisis, are also part of history.

However, beyond those names and stories, the general public really doesn’t know what hedge funds are, how they work and why they are not really such a reasonable investment. If you want to know more about this world and its dangers, read on.

What are hedge funds?

In a nutshell, hedge funds are a type of investment fund whose managers have no investment restrictions, so that they can bet on whether a security or an entire market will go up, down or both. More technically, according to the CNMV glossary, they are vehicles whose “main characteristic is that they can invest without the limitations that other funds have in terms of types of assets, diversification of their investments or indebtedness”.

How do hedge funds work?

The main objective of hedge funds is to produce a positive return in all markets, investing short (betting on falling prices) and long (relying on rising prices). So, for example, such a fund may bet on Repsol, a Spanish oil company, buying its shares, while betting that the market will fall, selling short. The key to the move is that betting on the market falling offers a kind of hedge to the bet on the company and at the same time stems the losses if there really is a generalized fall.

Hedge fund structure

Although their form of investment is what has given them their name, and also their fame, it is their structure that really defines them. Thus, hedge funds are a very different type of fund from the ones we usually know, as they are pooled vehicles that are only open to sophisticated investors, i.e. those that have characteristics such as: high net worth, many of these funds are managed by major investment banks, and that withstand losses well.

Both of these characteristics are key because they serve to underpin the hedge funds themselves. First, they require large assets because the amounts required and the fees are high. Specifically, hedge funds charge two fees to their participants: a fixed fee of around 2%, although it can be higher; and a success fee of 20% of the profits obtained. Secondly, they are “very risky” products, according to the CNMV itself, as they not only use complex investment instruments, but also combine them with dangerous formulas such as leverage, which can multiply losses.

The hedge fund trap: ‘much ado about nothing’.

Despite all this popularity, the use of complex instruments and high commissions, the reality is that the results obtained have not been significant in recent years. Thus, in 2010, they already had their first big crisis, to the point that a large number of them had to close because they could not find new participants. Things improved somewhat in the following years, but not much either, as the market in general rose steadily over the last decade, leaving little room for this type of funds that benefit more when markets fall.

The result is that hedge fund returns have been a mere 5% versus 13% for the markets. Despite this they have continued to charge their hefty fees, which led to net asset growth (a measure of whether investors are withdrawing money or investing money in funds, excluding the impact of investment returns) becoming increasingly negative until they were closed across the board.

And although they are now back in vogue because of rising rates, their total assets peaked at $4 trillion, experts really doubt that they can improve the performance of any market-indexed fund on a sustained basis.

Warren Buffett’s lesson and why to choose inbestMe

It was 2008, when famed investor Warren Buffett bet $1 million against a hedge fund manager that the money invested in an index fund would outperform that of a hedge fund of his choice over the next decade. Obviously, once the time passed Buffett won handily. That story is a reflection of the poor performance of hedge funds and why the index fund market has grown so much.

At the end of the day, it’s no longer just about performance, there’s much more to it. Today’s roboadvisors, automated asset management platforms, not only provide index funds or ETFs that have proven to be more profitable, but are also cheaper. They also allow investments in smaller amounts, are not limited to ‘sophisticated investors’ and are generally much more liquid (easier to buy and sell) than hedge funds. Finally, they also tend to represent a lower risk for users.

Therefore, investment alternatives such as inbestMe, a platform with five years of experience in Spain, which has automated portfolios of index funds, ETFs (also in SRI versions, socially responsible), as well as products such as savings portfolios or pension funds are always a better alternative. Buffett made his bet and won, probably if he had to make it today he would still bet on firms like inbestMe rather than the exclusive and classist hedge funds. So if you want to grow your wealth, don’t hesitate to visit inbestMe and benefit from its advantages.

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