Things You Should Know about Hedge Funds

Ironically enough, one of the questions that went unanswered recently was whether Hedge Funds would wise-up and become a little more conservative after the global financial bloodbath. To my surprise, the funds did not ease up their activities or change aggressive strategies, as per a report by Wharton.

So what makes the rules of the market not apply to them and what creates these special exceptions?

Hedge Funds can be defined as "privately owned financial firms that raise money from large investors, including individuals, pension funds and charities, for the purpose of increasing the value of the investment". The fact that they are so loosely regulated and have no obligation for disclosure of mode of investments and where they invest, gives them immense flexibility and decision making power. This kind of power is lethal when you consider that globally, Hedge Fund Managers manage more than $1.9 trillion in assets and generally keep 2% of invested assets and 20% of the profits, known as the "two and twenty rule."

With the financial heat worldwide, such funds are keeping a buffer of $400 billion as a backup for a worst case scenario, in spite of redemption pressure from investors and lenders. Now let us see what gives them this immense power:

Firstly, most hedge funds require a minimum investor amount of $1 million. Secondly, they usually keep a lock-up condition on the amount invested, which means that the investment (principal) cannot be withdrawn for 5 years or more. Thirdly, at any given point of time, there is a cap of withdrawing 20% of the profits and this cap may be reduced by them if required. Lastly, they are not required to file reports with SEBI or the SEC. This means that they most of the time withhold information even from their own investors. In fact, a few hedge fund managers in 2007 earned more that the salary of the top five CEOs of Wall Street combined. This is because irrespective of a loss or gain, hedge funds keep 2% of the assets invested and over 60% of their assets were invested in exotic derivative instruments between 1999 and 2006.

Hedge Funds make a little more sense now...I guess...