Many individuals use the terms savings and investing interchangeably, they are not the same thing. Saving is when you put your capital straight into a low risk low risk investment like a savings account or a high interest capital market account, where there is very little risk to the funds you have to invest.

Investing is when you’re placing the money you have to invest into an asset which may do up or down in value, for return higher than a high interest savings account, in return for taking some risks.

Investing is when you are using your savings to decide on and purchase an asset that you anticipate to increase in value in the medium to longer term, enhancing your capital value. This asset may go up or down in value, but will generate a return higher than that of a savings account, in return for taking some risks. Investment decisions are normally based on basic principles of that asset that are investing in.

Putting income into a high interest account to buy a car is saving your money, whereas putting your currency into a unit trust or a mutual fund to generate a nest egg sometime in the future is investing. When you have cash to invest, you should normally always seek some professional financial advice before you make any big decisions.

Investing vs Trading

What is the difference between investing and trading? Sometimes they use these terms interchangeably but they do mean completely different things. If you are a serious about controlling your very own cash and the risks associated with it, you require to understand the difference between these two terms.

With trading, the biggest difference is the time frame. Traders are typically very short term investors, at times buying and selling their positions on a daily basis and sometimes more than a few times in each day. They will generally make investment selections based on charts and the trends they are predicting and they are sometimes called chartists. Day traders also try to time the market, buying low and trying to sell high, quickly and as often as possible.

A Hedge Fund is a generic name for a pool of funds invested in a particular approach in a number of financial products and markets with the only aim of making an absolute return. Hedge Funds were originally investments that had a great deal of risks hedged, so theoretically, these funds will probably be lower risk compared to a typical mutual fund or unit trust.

Currently, the definition of Hedge Funds can mean a variety of diverse fund strategies. Some examples include, Equity Long / Short, Commodities, Foreign Exchange, Arbitrage, Bond Funds, Special Opportunities, Derivatives, Derivative Arbitrage, etc.

Hedge funds aim to achieve greater returns by taking riskier positions in their trades as higher risk equals higher returns.

Leverage

One of the main differentiatros that make a hedge fund different from a mutual fund is its ability to leverage. (Recently we have observed that the deficiency of risk management on these leveraged postions has underpinned the cause of the financial credit crisis. ) Most Hedge Funds are able to leverage as they have prime brokers who provide them with a line of credit, this allows the fund managers to take large positions to take advantage of little arbitrage opportunities. This can be highly risky if markets move unexpectedly and the leverage can leave a fund exposed like what happened with Long Term Capital Management.

Absolute return usually means to make a positive return on the assets you have invested, contrary to a regular mutual fund or unit trust when the main aim of the fund manager is to beat a stock market index. For example, it a UK equity fund would in all probability be assessed against the actual movement on the FTSE or in the US, a US equity fund will be compared to the Dow Jones Index. The fund managers will be congratulated for reducing the index, ie if the fund they are managing delivered a performance of 17% above the index increase of 13% they have carried out an excellent job, whether or not the market went down, if the fund manager made -3% return instead of the market or index recorded a -5% drop, the fund manager has done well for producing a much better result.

To the investor, they would have a 4% increase of return on capital invested in return for paying the additional cost of paying a management fee for the privilege of investing in that active fund. The alternative was to invest in a tracker fund, pick an index like the Dow Jones, buy a tracker fund or an Exchange Traded Fund (ETF), you pay very little or no management fee in comparison and you also would have achieved a 13% gain.

With absolute return funds, the intention is to invest to attain an absolute return, which means that you’ll normally make a positive return on your investment.

Hedge Funds and Management Fees

Hedge fund managers usually charge a yearly management fee ranging from 1% – 3% and as a further incentive for the fund managers to perfrom. In addition, they are paid a performance fee which can range from 10% to 30% on the excess return that was reached. A lot of investors are willing and happy to pay for this increased set of charges for the higher returns that they can get from investing in a fund of this type.

In general, investing in Hedge Funds is for expert or sophisticated investors, and normally a minimum investment is in the range of US $100,000. Funds normally recommend that this $100,000 be less than 5% of your total investment portfolio as it recognises that this is usually a riskier position compared to other investments. For sophisticated investors, investing in a hedge fund is a good method for diversification of their investment portfolio and can provide an enhancement to that portfolio’s overall return. Recently, a few fund management firms have started out to make hedge fund as an investment product to the man on the street, so do have a look around if you are interested. If you decided to invest in hedge funds, do get some advice from your banker or a financial advisor.

To read more about hedge funds, here are some online resources:

www.hedgefundintelligence.com

www.hedgefund.net

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