Wednesday, November 19, 2008

About Hedge Funds...

Hedge Funds get paid to manage risk. They assume the risk of others. 

They are different from conventional money management funds in the sense that money managers buy stocks and wait for stocks to go up. Hedge funds have been around for almost 60 years now. The first was opened in 1949, by Australian-born Alfred Jones.

Jones on the other hand supplemented his "buy and hold" stock positions with bets that some other stocks will go down, a sort of hedge. He smoked the competition and the modern day Hedge fund was born. 

Hedge fund focus on investing in a broad range of asset classes, from the increasingly wild world of stocks to credit markets, commodities, currencies and derivatives.

They are different from mutual funds in the way that not everybody can invest in them. Most funds have strict requirements regarding investors, usually of the net-worth variety, used to separate so-called sophisticates from average Joes.

Because they assume risk, therefore a return of 10-20% is not justified or too small. They need to make money, no matter the market goes up or down. 

Now, the question is why average Joes who might just buys stocks is talking about Hedge Funds...

During stock market declines, as we are witnessing now a days, the lenders in Hedge Funds get worried about their money and begin withdrawing money from Hedge Funds. Due to redumption pressure, Hedge Fund manager start selling stocks. Selling on large scale triggers stock price decline which sets panic in market. The panic encourages more selling and - well, you got the idea.

Example, Long Term Capital Management, or LTCM, almost took down the entire financial system when it collapsed in 1998. 

The sheer impact of Hedge Fund on stock market is the main reason behind many bailouts of late, back then the government convened Wall Street’s heaviest hitters -- JPMorgan (JPM), Goldman Sachs (GS), Morgan Stanley (MS) and others -- and forced them to clean up the LTCM mess themselves.

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