Where hedge funds were traditionally perceived as a way to neutralize the effects of a declining stock market, they are today being increasingly used in a much broader sense, as an effective and reliable form of wealth management and development.
With tax rates rising in many locations internationally, and the trade in bonds and other traditional wealth building tools experiencing a decline in returns, investors are currently looking to alternative measures to prevent much of their earned wealth from experiencing losses.
Low return rates in traditional investment methods have recently reignited an interest in other wealth management tools, including private equity, property, commodities and hedge funds. The hedge fund industry enables companies with a significant capital income to place assets into a structure that will give that capital an opportunity to preserve and augment, thus hedge funds are seen as not only a wealth management tool, but a wealth-building strategy.
With corporate tax rates reaching as high as 35% in many jurisdictions, including Malta, France and the USA, many investors internationally are choosing to set up hedge funds as a way to strategize and enhance financial results. For companies earning considerable capital that are forced into paying such excessive tax rates, placing wealth in hedge funds is considered a favorable solution against high corporate brackets.
Reports indicate that hedge funds are becoming more standardized components of investment portfolios, due to the fact that they are considered to be a more profitable wealth management tool than traditional stocks and bonds trading, as they generate higher returns over a longer period of time. Hedge funds allow individuals and businesses to invest and manage their wealth in an investment portfolio that is actively managed by a sophisticated investor. However, it is important to bear in mind that hedge funds are usually only open to accredited investors who have a net worth of more than $1.5 million, or income in excess of $200,000. Some hedge funds demand investment of $1 million or more, along with a significant amount of investment knowledge. Speaking on the matter, a professional analyst within the industry stated:
“Growth in alternative investments, including hedge funds, is being geared by demand from investors with significant capital who are not satisfied with the returns generated from traditional investments”.
Hedge funds were first launched in 1949 as a way to counterbalance the impact of falling prices on the stock exchange. Originally, they were perceived as very high risk, particularly if managed incorrectly. Risks included significant loss of funds, for example, the collapse of two Bear Stearns hedge funds in 1997, where high-risk strategies were employed in line with market predictions, but the securities market behaved well outside of the portfolio manager’s expectations, resulting in a chain of events that collapsed the funds. In addition, hedge funds have always been unregulated as it’s assumed that the investors are knowledgeable and realize the speculative nature of the fund.
The current philosophy, however, is that where other investment approaches are often likely to experience loss of value over a shorter period of time, by placing funds within a specially formulated portfolio, they can be protected and as such they are increasingly being used as an excellent way to garner maximum returns. In recent years, they have therefore experienced an increase in usage. The opening of hedge funds and other alternative assets has experienced a 17% rise in the second quarter of this year, with hedge funds accounting for almost three-fifths of that category overall. Today, about 300 hedge funds manage more than $1 billion each and represent roughly 90% of the assets in the industry. Speaking further on the matter, the analyst stated:
“Hedge funds are a sophisticated tool used by investors to lessen the risk of exchange rate fluctuations. Their popularity has evolved in recent years, due to fears of volatility and dramatic drops in value on the stock exchange.”
A form of wealth building that can be compared with hedge funds is mutual funds. Like hedge funds, mutual fund managers pool in money from investors to be managed. Investors in hedge funds can withdraw their money, just as they can in mutual funds. Some of the key differences are, where hedge funds are unregulated, mutual funds are heavily regulated with a focus on investor safety. Mutual funds work within a risk controlled framework with restrictions on risky asset classes, whereas hedge funds can invest in any asset class with high levels of flexibility. Furthermore, hedge funds are targeted at the extremely wealthy, whilst mutual funds are a wealth building opportunity for a wider selection of investors.
Hedge fund managers aim to produce much higher returns than mutual funds or other investment vehicles, and try not to be dependent on the market. So although there is great risk involved in hedge funding, there is also greater distribution. A hedge fund manager will create a unique portfolio that places the money into various investments; for example where money is invested into a number of asset classes on the stock market, if one currency suddenly experiences a dramatic loss in value, the value of the others will increase, thus enhancing the overall net profit of the hedge fund.
Asset classes that can be invested into hedge funds go beyond capital funds, and can include real estate, commodities, bonds, art, private partnerships and even website domain names. The hedge fund manager will adopt a range of techniques to acquire high returns, including, amongst others, arbitrage, leverage and positive carry. In a similar way to both arbitrage and leverage, positive carry involves, for example, an investor receiving interest in one currency on the currency market that is more than that which they have to pay to borrow in another currency, resulting in maximum positive returns.
During the first half of 2011, hedge fund investors entrusted over $20 billion into the industry, while estimates of new assets flowing into hedge funds far exceed this amount.
There are an estimated 10,000 hedge funds in the US today and that number continues to grow, whilst the value of hedge funds exceeds the $2.5 trillion mark. With more and more people choosing to set up a hedge fund as a wealth management tool, the industry has experienced rapid growth in recent years, and is estimated to have around US$1.9 trillion in assets.
The evolution of hedge funds from an elite investment to a standard component of investment portfolios represents a change in the perception and potentially, the future of hedge funds. As increasing numbers of investors are choosing to open up a hedge fund, it is believed that greater hedge fund openings can be expected in the future.
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Category: Wealth Management