Whilst mutual funds and hedge funds are both managed investment vehicles, the main difference between the two is that a hedge fund manager approaches the issue much, much more aggressively. When asking why you should invest in hedge funds over mutual funds, this should be your number one consideration. If you are going to invest your money, hard-earned or inherited, you want to know that you are placing it in the hands of a manager who is willing to go the extra mile to insure returns. But that is just the tip of the iceberg. Here are a few other points you should be aware of.
Aggressive Management Seeks Higher Returns
To put it quite simply, when hedge fund manages a portfolio, they don’t always look at market variables to determine where they will place the investment capital. Although they will use that data as a benchmark, they seek higher returns by seeking to analyze the underlying asset to determine its performance apart from the market index. In other words, risk management is based on the quantification of a specific derivative or class of derivatives as opposed to how the market forecasts are being made. It may sound complicated but with the use of such things as alpha generators, hedge fund managers seek to generate higher returns.
Why Are Alpha Returns Thought to Be Higher?
Here again, it’s all about the finer details of risk management. A hedge fund manager seeks to look at how security is actually performing and then will invest and get out again based on quantitative data. In many types of funds, managers take the ‘risk’ of trying to predict where the market is going and make investment choices based on forecasts. Yes, there is the potential for a beta return to be higher but the bottom line is that the risk is also proportionately greater. Some investors like the idea of risk and don’t mind taking a chance, but for those of a more conservative nature looking for a surer and therefore higher return, an alpha-generated investment is their safest solution.
Summing Up an Alpha-Generated Investment
Still, having trouble getting your mind around exactly what an alpha-generated investment is? Here’s a simple summary. An alpha is what is measured by the return on a portfolio that is higher than would have been estimated originally by using beta forecasts based on market movement. When added to the volatility of beta risk, alpha minimizes that risk because it is based more closely on the actual performance of the underlying security. In other words, the alpha generator closely follows actual movement and weighs that against riskier forecasts.
All this is probably Greek to the new investor, but the bottom line is that if you want to minimize your risk, find a hedge funds management company that employs alpha-generated investments. You should be able to look for higher returns with less risk than from a managed fund that relies solely on market movement.
