Unless you represent your company’s pension fund, or are an incredibly wealthy individual, you will not be eligible to participate in a hedge fund or need to select a hedge fund accountant. You still may find the need to recognize how a hedge fund works if you are searching for a better understanding of how your company’s pension fund works. A hedge fund manager deals with an actively traded account or fund, representing a group of individuals. Investors participate by purchasing shares in the fund. Typically a hedge fund manager will also buy shares and participate in his own fund. This ties his fortunes to those of his customers.
How the hedge fund operates is just what sets it apart from other funds. As an example, a mutual fund is designed to be stable with constant, moderate return on investment. A mutual fund, just like a hedge fund, is open-ended, meaning money may be withdrawn and deposited throughout the participation. A mutual fund grows its principal by investing the capital in dependable, positive-growth companies, like utilities. A mutual fund purchases stock only, and it does not engage in short sales. If a mutual fund is a bit more aggressive they may look to target higher growth businesses, in the technology sector for instance and gain a slightly higher return for a slightly greater risk. In a recession a mutual will generally generate losses. The retirement accounts based on mutual funds this decade have taken a huge hit as a result of economic downturn.
In contrast, a hedge fund runs very diversely. Stocks can be bought or purchased long, but in an economic downturn, stocks can as well be sold short. This means that a positive return on investment (ROI) can be realized irrespective of the state of the economy. On the other hand, the basic law of finances that a higher return always comes at the cost of a higher risk binds a hedge fund. Using the shorting strategy is part of the hedge funds higher risk. An investor will never lose more than their investment if they purchase long. If the investor purchases short, he can not just lose his initial investment, he can find himself left with a debt. The expertise for handling this risk and effectively forecasting economic growth and downturns is much more difficult than choosing high-growth companies. This is why it is so important to evaluate the credentials for any possible accountant for the hedge fund.
Another tactic utilized by a hedge fund broker is leverage. This means he is able to purchase a stock for only a portion of the stock value. When purchasing in this way the stockbroker will make up the difference, in exchange he expects that the price of the stock will not change enough that his participation would be endangered. The leverage is considered the ratio of the stock value to the investment total. An example of this would be if the leverage was 2:1, if your stock grows 1% you would yield a 2% return on your investment. It is also possible for a hedge fund manager to work with a 10:1 leverage or higher. This gives them the opportunity to realize huge gains. This too opens them up to the risk of a big loss.
There are two things that investors use to qualify a successful hedge fund accountant: long-term ROI and draw downs. 20 years is an effective time horizon bare minimum. By examining the ROI from beginning to end you can observe what the return is today on an investment that has been held for 20 years. It’s also wise to watch negative digressions from a straight upward line of growth. These are generally known as draw downs. A draw down of more than 20% signifies considerable risk in the account.
One must do so much more research to fully understand hedge funds. Nonetheless, this information can get you started in understanding basic hedge fund operation.
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