|Bratan lake and Ulun Danu temple, Bali, Indonesia|
“A hedge fund is a portfolio that is structured as a limited partnership between a small number of partners. It entails incentive fees, does not have any investment constraints and is generally of low liquidity and has a low degree of transparency of the portfolio positions. It often displays creative and new investment techniques, with exposure to alternative premiums and delivering returns that are due to market inefficiencies. A lot of the investments are considered unscalable.”
A hedge fund is not hedged in terms of not having exposure to the underlying market. It can be, but this is not a prerequisite for being a hedge fund. Thus, a hedge fund can simply be long or short financial products.
Limited partnership means the managers do not bear responsibilities for where they invest their clients’ money. It can be risky for an investor to give money to these managers.
Low liquidity means the financial products in the respective portfolio are difficult to liquidate/sell in the financial market as there is no appropriate pricing available within a short or reasonable time period.
At times this can mean days or weeks before a cash flow can be obtained. Low transparency means that the financial products, in which the hedge fund is invested, will not be disclosed to the final investors.
Alternative premium means the returns received by being exposed to credit risk (e.g., buying a risky bond), to interest rate risk (e.g., buying a long-term bond), liquidity risk (e.g., investing in small capitalization stocks in Korea) and volatility risk (e.g., being exposed to panic on the market, short options strategies).