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Hedge Funds Take Strain In Volatile Market

28 October 2008 - Markets - Editor

A report by the Bank of England on Tuesday noted that bank credit risks have been reduced and money market pressures have eased off following the recent financial sector bailouts across the United States and Europe. However, the report added that risks in the broader financial system remain, with hedge funds being particularly vulnerable in the current global financial crisis. An increase in redemption requests has put hedge funds under additional funding pressures, resulting in the third quarter of 2008 being one of the worst recorded by hedge funds.

In financial terms, a hedge is an investment that is taken out with a view to reducing or canceling out the risk of another investment. While each hedge fund employs its own strategy to determine the type of investment it will make, as a class hedge funds invest in a wide range of investments which may include shares, commodities and even works of art. Hedge funds further attempt to counter potential losses in their principal markets by employing a variety of investing methods, including short selling and leverage.

Hedge funds are generally established as investment partnerships with a limited number of investors who are required to put up a large initial investment, which must remain in the fund for at least twelve months. Hedge funds have been referred to as “mutual funds for the super rich”. This is because, although they are similar to mutual funds where investments are pooled and managed professionally, hedge funds are more flexible in the type of investment strategies employed. Unlike mutual funds, hedge funds are unregulated and the investors have to meet certain criteria. For example, United States law requires that the majority of investors in a hedge fund must be accredited, having a significant amount of investment knowledge, with a predetermined level of annual earnings and a net worth of over $1 million.

The goal of hedge funds when they were first established was to maximize return on investment, while at the same time attempting to reduce risk. These days, however, hedge funds may employ a number of different investment strategies, with hedge fund managers often making speculative investments, which may result in hedge funds carrying substantially more risk than the overall market. This high risk factor is likely the motivation for many hedge fund investors pulling out of the market. The current trend of redemption requests is likely to continue, or maybe even increase, forcing hedge funds to sell stocks at any price, which in turn adds to the volatility of the market.

 


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