Hedge fund

From Recessipedia

As in the common term "hedging your bets," hedging is basically an investment strategy that involves taking opposing positions in the same market in an attempt to gain regardless of which direction that market moves.

For example, when the price of oil is volatile, the hedge investor could buy instruments that track the price of oil and at the same time sell short shares in oil companies. If the price of oil rises, the shares in the oil companies could be expected to rise also. The investor expects that the gain in the oil-tracking instruments should be greater than the loss on the short sales of oil company stocks. If the price of oil declines, the investor calculates that the gain from the short sales should be greater than the loss on the oil-tracking instruments.

While the concept is simple, the calculations and execution can be highly complex. Hedge funds use sophisticated market-modeling computer programs, as well as the experience of the managers and specialists themselves to determine their investment strategies. Hedge fund managers use all the investment instruments--equities, bonds, commodities, futures and options--and often develop complex mechanisms linking many different types of investments. In theory hedging reduces volatility and risk. In practice, however, the complex calculations and aggressive strategies, combined with the large size of some portfolios, have sometimes resulted in large losses that have affected the larger markets.

It is important to note that most hedge fund managers are responsible professionals, many with winning records. The idea that risk and reward should be proportional is essential to free markets. It is also essential to note that historically hedge funds have not been regulated, as are mutual funds. In almost all cases investors have to prove that hedge funds are suitable investments for them; that usually means investable assets exceeding $1 million.

The questions currently being debated by investors, hedge fund managers, exchanges, and regulators is how much, if at all, hedge funds should be regulated. A balance must be struck between allowing managers to ply their trade and for high-level investors to seek large returns while minimizing any spill-over effect into larger markets that could damage non-hedging companies and investors.