Hedge funds are founded when capitalists form a domestic limited partnership (LP) or an offshore limited company (Ltd.) as a holding company. “Limiteds” are funds based in offshore locations, such as Barbados or the Grand Cayman Islands, for example. These are called limiteds, because they are registered and held at custodian banks regulated by a government outside of the United States. Some foreign hedge funds are designated as “pass-through” funds. Pass-through funds have the exact same investment strategy and fund managers offshore as onshore, which means their monthly performance returns are the same. Capital managers develop one or multiple investment strategies to achieve for their investors gains which exceed traditional approaches to investing in capital.
Hedge funds strategies can be varied to highly unique in how they aim to beat the market and what trading methods they use. Broadly speaking, fund managers leverage their available cash for trading activities in which they buy, sell and swap stocks and bonds. You probably have heard of someone ‘shorting’ a stock when a price is anticipated to lose its value… Well, stocks can be held as a “long” or “short” position. When a manager believes a stock is undervalued, then he or she wants to buy the ability to sell a minimum number of shares at a higher price at a future date. The short and long positions equate to a sum of assets that exceeds 100% when both long and short positions are held by the same manager. It’s weird (but fun) to see a statement show a combined asset value of 125%.
Other more esoteric strategies involve geographic region bets in Asian, European or South American markets. Countries in Asia and South America are developing regions; therefore, you would expect to find multiple emerging market hedge funds on the market. Fund managers actively monitor and correct the amount of risk the fund is subject to throughout each day for hedge fund type. These are termed exposures.
Hedge funds gain their notoriety for becoming proprietary experts at a strategy based on economic and market research or software engines that run algorithms. Here are some classes of hedge funds: (1) long/short, (2) multi-strategy, (3) macro, and (4) event driven. Fund managers even have dedicated commodities desks, or trade in renewable energy, and real estate. It gets more interesting though, some LPs have multiple hedge funds within them while others are single fund LPs. The size and number of hedge funds operating on the market alone is vast, and you can always count on learning something new or hearing about them in financial news.