For those who may not be familiar with the term – ‘Hedge funds’ are Speculative funds managing investments for private investors. They vary greatly, but have some or all of the following characteristics:
They will be based offshore and are virtually unregulated.
They will have small groups of investors, usually rich individuals or institutions.
They will aim for an absolute (positive) rather than a relative return.
Their managers will be incentivised by a performance fee.
One could say that they in a way are instruments to measure the economic growth and are some what very similar to Mutual funds in India. However, the essential difference being that mutual funds are subject to market risk and any movement will directly affect the economy. Hedge funds, on the other hand, are extremely flexible in their investment options. They use financial instruments generally beyond the reach of mutual funds. Mutual funds are restricted by government regulations and disclosure requirements that largely prevent them from using short-selling, leverage, concentrated investments and derivatives. This flexibility, which includes use of hedging strategies to protect downside risk, gives hedge funds the ability to best manage investment risks.