Are hedge funds a good investment for a common man?
We all have heard about hedge funds. From its words itself it gives a feeling of safety and assurance.
I have heard only rich people using the services of hedge funds.
I will try to explain what are hedge funds and then we will know how they are managed.
For sure hedge funds are not like traditional mutual funds.
The benefits that investors can have by investing in hedge funds are incomparable.
Certainty of returns and customised service is one of the prime attractions of hedge funds.The portfolio of hedge funds are managed with utmost care.
The hedging hints at maximising returns with minimum of risks.
Hedge fund is managed by a money manager.
Kalpesh Kinariwala is one such money manager who manages one hedge fund.
His hedge fund is called Kinariwala’s Capveda Capital (India) Advisory fund. He operates this fund from Mumbai.
Hedge funds and mutual are not the same.
In mutual funds, we just contribute our money in a common pool, and then the fund manager does the rest.
While we are investing is mutual fund, the fund manager gives no assurance of returns.
But in Hedge Funds there is a assurance of protection of capital.
Here there is a kind of partnership between the money manager and investors.
There is a legal agreement between investors and money manager.
In case the company goes bankrupt, investors cannot demand more money than the money they have invested in hedge fund.
The money manager is like a paid partner. Investors pool their money in the hedge fund. They strike a partnership deal with the money manager.
And then the money manager gets paid a percentage of profit that the company generates out of the invested fund.
Money manager is the individual who starts the hedge fund, attracts investors and then form a partnership.
So the money manager is everything of the fund, so he also shares profit with the investors.
The main objective of hedge fund is to continue generating profits (small or big) regardless of markets performance.
Idea is to continue generating positive cash flow always. If market is bad, the money manager will switch his funds from equity to debt.
With the authority to invest the pooled money wherever he wants (legally), the money manager assures positive returns from hedge funds.
So if you will ask me, are hedge funds a good investment? I will say, it certainly is.
In order to understand are hedge funds a good investment for a common man, let me give you a hypothetical example.
Suppose a hedge fund in name of a company like ‘XYZ Capital Fund’ has a money manager named Mani.
He struck an agreement with the investors that 30% of all profit, will be his income.
But he will charge 30% only when the returns are over 7.5% per annum.
Suppose the return to investors are 4% in year 2011-12, then Mani will not charge money.
The value of minimum return (like 7.5%) is generally based on rate of inflation prevailing in the host country.
In India the average inflation in last 30 odd years has been close to 7.5%, so XYZ Capital Fund sets target to give returns above 7.5%.
If returns are not above 7.5%, then Mani will not charge anything.
This is a big assurance to the investors.
The higher is the assured returns more investors will be attracted to invest in that hedge fund.
The only condition of hedge fund is that, beyond a minimum returns, the profit will be shared by the money manager (Mani).
The partnership agreement of XYZ Capital Fund also allows Man to invest in any investment option.
Starting from real estate, equity, mutual funds, post office savings, precious metals, or anything legal.
With these preconditions, the money manager Man will start investing investors funds and generate profits.
Suppose one day, Mr. Ambani calls Mani and says that he wants to invest Rs 500 crore in his hedge fund.
Mani used those Rs 500 crore to buy a multi storeyed commercial property in one of the best located shopping malls in Mumbai.
Mani let that commercial space on hire to SHOPPERS STOP retailer and started earning Rs 3.5 Crores per month as rental income @ 8% per annum.
So Mani is generating income above 7.5% p.a, means he is eligible for profit sharing.
His income will be Rs 500 Crore x (8%-7.5%) x 30% = Rs 75 Lakhs per annum (Rs 6.25 Lakhs per month).
So the more will be the income of the investor, higher will be the income of the money manager of hedge fund.
You must have heard a lot in news papers and articles that how costly are hedge funds.
Even in our example, if we will see superficially, we will notice that the money manager has charged 30% profit sharing.
Because of the condition of high profit sharing the money manager made Rs 75 Lakhs per annum.
But this hedge fund money manager has charged this after he paid Rs 3.5 crore to his client.
At present this form of wealth management is not so popular in India.
There are not many Hedge Funds operating in India.
These hedge funds are finding hard to convince rich to enter into partnership.
If you ask me that are hedge funds a good investment for a common man? My answer will be no.
Not because common man does not like such money management, but limitation is with the hedge fund concept.
Hedge Funds likes to include less number of partners with maximum possible pooled fund.