Helping You Understand The World Of Hedging – What It Does And How It Works

By Author: Avendusgroup
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Before we take a deep dive into the world of Hedging and find out why multiple finance companies in India and over the world use hedging as one of their strategies for fund management, let us help you understand what it means to hedge.
Typically, hedges are used by gardeners as an alternative to traditional fences to mark a boundary, creating a barrier that highlights the limits, provides security and privacy. Similarly, Hedge fund managers use the hedging strategy to limit a funds exposure to market risks and achieve financial security.
What are hedge funds and how did they originate?
A hedge fund is an alternative investment fund that creates a common pool of money from multiple interested investors. The fund manager are typically institutional investors who use various unconventional investing strategies to avoid risks and make a profit.
These funds were started by fund management companies with the idea of being immune to the risks of market drawdowns and realizing a return on investment regardless of any turmoil in the market. Naturally, finance companies in India were drawn towards this strategy ...
... and started creating hedge fund services to exploit the hype.
How do they operate?
Hedge fund managers utilize various financial instruments and strategies to invest across an array of asset classes. They do this to diversify the risks associated with an independent asset class and their broad goal is to enable most of their investments to generate healthy returns and be less exposed to market risks. Since their fund management and investment strategies are broad, generalizing what they do becomes difficult. However, a typical hedge fund prefers investing in public equities over private equities due to them being more liquid than the latter.
These funds earn money by charging management fees which are around 2% of the total assets managed along with performance fees which are around 20% of the profits earned.
What are some of the most popular strategies a hedge fund relies on?
Equity Strategy – A go-to strategy for most funds, it focuses on balancing the short and long positions of equities in the public market to generate high returns taking less risk.
Event-driven Strategy – This strategy banks on the once in a lifetime possibility of an event that drastically changes the company and affects its securities. For eg: An acquisition, merger, or bankruptcy.
Global Macro Strategy – This strategy predicts a radical shift in the global financial markets due to weather, politics, civil unrest, war, etc., and invests in everything from securities and stocks to commodities and derivatives.
Arbitrage Strategy – A relatively new strategy that studies and analyses the overall market sentiment and behaviour and looks for errors and inconsistencies in the price of securities.

Unlike other financial companies in India, hedge funds are not required to register with SEBI as they are considered private investment partnerships. Their investor base is largely made of HNIs, commercial organizations, endowment funds, banks and pension funds. These funds have a very complex structure and their dependence on unconventional investment strategies make them risky investments. Thoroughly researching a fund before getting involved with them is therefore highly recommended.