What is a Hedge Fund?

by Money Hammer

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about

Hello! I make songs and videos that use brutal heavy metal to teach basic personal finance and investing. At the time of making this song, hedge funds have been in the news because of the WallStBets/GameStop stock story. This video attempts to explain what a hedge fund is.

My sources for this were Stephen Brown's article "Why Hedge Funds?" in the Nov/Dec 2016 issue of Financial Analysts Journal and Keith Black, CFA's article "Investing in Hedge Funds: A Survey" which is on the CFA Exam 2 syllabus (or at least it used to be).

It's hard to describe a complicated thing in the space of a death metal song, so to those curious to learn more, or to those who know this stuff and think I'm being imprecise, the three strategies I'm trying to describe in the song are:
1.) zero beta strategies and long-short equity strategies
2.) merger arbitrage
3.) various arbitrage strategies betting on believed security mispricings

lyrics

The term hedge fund applies to a variety of investment firms using many different investment strategies. The only thing most hedge funds have in common is that they use techniques which make them potentially too risky for a typical investor. They do not market their services to the public and restrict investment to investors with a lot of money. Because of this, compared to a typical mutual fund they do not have to disclose as much info to the public.

The name "hedge fund" came from a 1966 article in Fortune magazine. The author mistakenly believed a certain fund's strategy was a "hedge" in the sense of a hedged bet. The name has stuck ever since. The name has stuck ever since.

Some common hedge fund strategies include:
(1) buying stocks they expect to go up in value while simultaneously betting against, or shorting, similar stocks they expect to go down in value.
(2) making a series of investments after a company announces it is going to buy another company, in effect betting the deal will go through. If it does, the hedge fund makes money
(3) making complicated bets on the prices of sophisticated financial instruments like options and convertible bonds

Individual hedge funds vary wildly in performance. Investing in a single fund, for those who can, is extremely risky. But research shows that investing in a diversified group of several hedge funds may have a role in certain portfolios, though this remains risky.

A normal person can invest in hedge funds by purchasing an exchange traded fund that invests in hedge funds. But again this carries high risk, and should only be done with small amounts of money for amusement, not for serious investment.

Hedge funds are interesting but their risk makes them unsuitable for most investors.