Hedge Funds

A hedge fund is a lightly regulated investment partnership that
uses a range of investment techniques and invests in a wide array of assets
to generate a higher return for a given level of risk than what’s expected of
normal investments. In many cases, but hardly all, hedge funds are managed
to generate a consistent level of return, regardless of what the market does.

Directional funds

Directional funds are hedge funds that don’t hedge — at least not fully. Managers of directional funds maintain some exposure to the market, but they try to get higher-than-expected returns for the amount of risk that
they take. Because directional funds maintain some exposure to the stock market, they’re said to have a stock-like return. A fund’s returns may not be steady from year to year, but they’re likely to be higher over the long run than the returns on an absolute-return fund.

Directional funds are the glamorous funds that grab headlines for posting double or triple returns compared to those of the stock market. The fund managers may not do much hedging, but they have the numbers that get
potential investors excited about hedge funds.

A directional strategy is most appropriate for aggressive investors willing to take some risk in exchange for potentially higher returns.

A “non-directional fund" OR an absolute-return fund

Absolute-return fund is designed to generate a steady return no matter what the market is doing. Alfred Winslow Jones managed his pioneering hedge fund with this goal, although the long-short strategy that he used was just one of several methods that snagged him consistent return.


Although absolute-return funds are close to the true spirit of the original hedge fund, some consultants and fund managers prefer to stick with the label absolute-return fund rather than “hedge fund.” The thought is that hedge funds are too wild and aggressive, and absolute-return funds are designed to be slow and steady.

In truth, the label is just a matter of personal preference. An absolute-return strategy is most appropriate for a conservative investor who wants low risk and is willing to give up some return in exchange. That falls in category of portfolio management.

Hedge fund managers can use many different investment tools within an absolute-return strategy.


Some say that absolute-return funds generate a bond-like return, because like bonds, absolute-return funds have relatively steady but relatively low returns.
The return target on an absolute-return fund is usually higher than the long-term rate of return on bonds, though. A typical absolute-return fund target is 8 percent to 10 percent, which is above the long-term rate of return on bonds and below the long-term rate of return on stock.

Hedging vs speculating

Hedging is the process of reducing risk. Speculating is the processof seeking a high return by taking on a greater-than-average amount of risk.
Although hedging and speculating are opposing strategies, many hedge funds today use both.