What are Hedge Funds in India? || Meaning, Features & Benefits:
Do you know what hedge funds are and why it is used?
Don’t worry if you don’t!
Hedge Funds are not that much popular in India likewise the mutual funds are.
In this, there is a high risk associated with the investments that are traded in these types of funds.
This article “What are Hedge Funds in India?” will provide clarity on the definition of hedge funds, how to make investments in hedge funds, and much more understanding throughout the article.
Hedge funds are generally a complicated instrument to understand and it is unlike mutual funds.
So, let’s start with the definition,
What are Hedge Funds?
According to the Securities and Exchange Board of India (SEBI’s) statement, Hedge Funds, including funds of funds, are unregistered private investment partnerships, funds or pools that may invest and trade in many different and other markets, strategies, and instruments and are not subject to the same regulatory requirements as mutual funds.
In simple terms to hedge means to safeguard, and in the reference of investing, it means to get protection against risks.
The funds of hedge funds are collected from the investors that include banks, insurance firms, and endowment and pension funds.
They pooled the money which they collected from the investors and then they make their investment in the securities that lie in the national and international markets.
Just because of this, there creates a chance from where these funds often function as overseas investment corporations or private investment partnerships.
They do not need to get registered with SEBI, nor do they need to disclose their NAV at the end of the period like other mutual funds.
These types of fund portfolios consist of asset classes such as derivatives, equities, bonds, currencies, and convertible securities.
They are also considered alternative investments.
The functioning of these funds requires aggressive management as the assets have strived to “hedge” risks to investor’s money against the market movements.
Unlike the equity mutual fund, they tend to employ substantial leverage.
There is one benefit for the hedge fund investors that they can hold both long and short positions, including positions in listed and unlisted derivatives.
What are the different types of markets in Hedge funds?
Mainly, there are three categories:
- Off-Shore Hedge Funds: The fund that is created outside of the own country is Off-shore hedge funds.
- Funds of funds: The funds that are basically mutual funds that make the investment in other hedge mutual funds rather than individual lying assets.
- Domestic Hedge Funds: The fund that is open for the investors that reside in the country and are subject to pay the taxation on it.
Who should invest in Hedge Funds?
Usually, all the types of funds that can be hedge funds or mutual funds are independently managed by the expertise managers.
For the above reasons, the fees are higher in these kinds of funds.
Hence, they are affordable and feasible only for the one who is financially well-off.
The investors or you and I required having some surplus funds and also the ability to take the aggressive risk in a manner to buy or sell the assets at a speed to keep up the momentum in the market.
As you know, the higher the structural complexity more will be the risks.
Hence, the expense ratio that is the fee to the fund manager is way higher for hedge funds as compared with the regular mutual funds.
It can be a range of 15% to 20% of your returns.
In the end, also it depends on the fund manager.
Therefore, unless you have full faith in your fund manager, investing in hedge funds can give you nightmares.
What are the Benefits & Features of Hedge Funds?
The hedge fund industry in India is relatively young, and it got initiated in the year 2012 when the Securities and Exchange Board of India (SEBI) allowed alternative investment funds (AIF).
They have the following features:
a. High Net-Worth Investors
The funds of hedge funds are collected from the investors that include banks, insurance firms, and endowment and pension funds.
Only qualified investors lead to investing in hedge funds. The minimum size of investing for investors investing in these funds is Rs 1 crore.
b. Diversification in Portfolio
This type of funds used to have variation in the portfolio of investments that is bonds, currencies, stocks, derivatives, debt, real estates, and equities
c. Higher Fees
Hedge fund managers work on the concept of both expense ratio and management fee.
Ideally, it is ‘Two and twenty’, meaning there is a 2% fixed fee and 20% of profits.
As for hedge funds in India, the management fee can be below 2% to below 1%.
And the profit-sharing ratio lies between 10% and 15% generally.
d. Higher Risks
Hedge funds investment strategy also gives exposure to the funds for huge losses.
The Lock-in period in a hedge fund is generally and relatively long.
The leverage that is used by these funds can turn investments into a significant loss.
e. Taxation
The Category III AIF (hedge funds) has not given the allowance of status on tax.
The above line states that these funds are taxable at the income the investors earn on their investment level.
What are the Strategies for Hedge fund investing?
There are many strategies and somewhat is mentioned below:
- Event-Driven
- Long/Short Selling
- Arbitrage
- Market Neutral
- Market Driven
How do Hedge Funds work?
These types of funds use a different methodology of trading techniques due to the securities and the assets they are investing in.
Mainly, they used to make their investment in equities, debt, and derivatives.
In this, the asset managers give their best to reduce or to remove the market exposure and also generate good returns in spite of market movement.
They function in small market sectors to reduce their risk by making more diversification.
Some of the strategies that hedge fund managers use are as follows:
a. Sell short:
Here, the fund manager, hoping for the prices to drop, can sell shares to buy-back in the future at a lesser price.
b. Use arbitrage:
Sometimes the securities may have contrasting or inefficient pricing.
Fund Managers use this to their advantage.
c. Invest in an upcoming event:
For example, some major market events like acquisitions, mergers, and spin-offs among others can influence the manager’s investment choice.
d. Invest in securities with high discounts:
Some companies when faces financial stress or even insolvency they will sell their securities at an unbelievably lower price.
The manager may decide to buy after calculating the possibilities.
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This article on “What are Hedge Funds in India?” wanted to provide knowledge on hedge funds by stating the definition and the benefits of making an investment in this kind of securities.
I hope that you understand well about hedge funds and if not then don’t worries please let us know your query we will be grateful to help you in any way.
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