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Hedge fund basics

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What are hedge funds?

Hedge funds employ non-traditional strategies including long and short positions, leveraging, arbitrage, swaps, etc. to manage risk and enhance potential return. Global estimated assets under management of the industry in 2020 sat at USD3.36 trillion. 1

A comparison between mutual funds and hedge funds

A comparison between mutual funds and hedge funds

1 Source: eVestment, data as of end of 2020.

Key features of hedge funds

  • Adapt to various market conditions: By employing long-short strategies, it is possible for hedge funds to manage the ups and downs of the market cycles and profit in rising or falling market conditions. These strategies may provide potential downside protection against market crash and demonstrate better performances during market downturns.
  • Diversify investment risks: Hedge funds can act as complement to traditional assets such as stocks and bonds in a portfolio and aim to achieve more steady return. With a wide range of investment tools and strategies and more flexible investment rules, hedge funds tend to have lower correlation to traditional assets and provide returns regardless of market movements, resulting in lower volatility of the overall portfolio.
Key features of hedge funds

* Maximum drawdown measures the largest drop from peak to bottom in the value of a portfolio before a new peak is attained. For illustrative purposes only.
Source: AIMA Research, data as of April 2020.

Hedge funds exhibit lower sensitivity to global equity market

Source: MSCI, Hedge Fund Research, FTSE and Mercer Calculations. Beta estimated using monthly returns in excess of the risk free rate, FTSE 3-month T-Bills as of end of 2019.

Truth: Hedge funds can employ different strategies (e.g. long and short positions) to contain loss during market downturn. Therefore, hedge funds are theoretically less volatile than traditional long-only funds.

Myth 1: High volatility?

Source: AIMA Research, data as of April 2020. For illustrative purposes only.

Truth: Use of leverage is common among hedge funds with an aim to enhance potential portfolio returns. The amount of leverage used by different hedge fund strategies can vary substantially, but it is generally lower than that of broker-dealers and insurance companies.

Myth 2: High leverage?

Source: AIMA Research (2016), leverage range based on various prime broker estimates over 2014 to 2016.

Truth: Hedge fund is not about making ultra-high returns, but rather about achieving potential returns with lower volatility by employing various strategies in different market cycles. Historical data suggest that performance of hedge funds lay between global equities and government bonds over the long term.

Myth 3: Ultra-high return?

Source: HSBC Alternative Investments Limited, Bloomberg. Data as of February 2021.

Common strategies of hedge funds

Hedge funds are fund pools that aim to achieve potential returns by employing flexible investment strategies such as:

Common strategies of hedge funds

Source: HSBC Asset Management. For illustrative purposes only.

Major risks of investing in hedge funds

Major risks of investing in hedge funds

Longer time horizon for hedge fund strategies

Some of the hedge fund strategies such as event driven and distress debt may impose lock-up periods and restriction on redemption according to their needs, as they may invest in non-traditional assets with lower liquidity, employ higher leverage levels or invest with a more concentrated portfolio. Therefore, a longer-term investment horizon would be more suitable for hedge funds strategies.

Longer time horizon for hedge fund strategies

Source: AIMA and Chartered Alternative Investment Analyst Association (CAIA) research, 2017 data.

Advantages of funds of hedge funds

Hedge funds have unique advantages and risks compared to mutual funds. A fund of hedge funds is a basket of hedge funds in which investors may leverage on fund manager’s professional risk management to achieve strategic allocation and the long-term goal of capital growth.

Advantages of funds of hedge funds


The value of investments and the income from them can go down as well as up and investors may not get back the amount originally invested. The capital invested in the fund can increase or decrease and is not guaranteed. The performance figures contained in this document relate to past performance, which should not be seen as an indication of future returns. Future returns will depend, inter alia, on market conditions, fund manager’s skill, fund risk level and fees. Where overseas investments are held the rate of currency exchange may cause the value of such investments to go down as well as up. Investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in some established markets. Economies in Emerging Markets generally are heavily dependent upon international trade and, accordingly, have been and may continue to be affected adversely by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries and territories with which they trade. These economies also have been and may continue to be affected adversely by economic conditions in the countries and territories in which they trade. Mutual fund investments are subject to market risks, read all scheme related documents carefully.

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