What Does a Hedge Fund Do?

A hedge fund is an investment fund that aims to minimize financial risks and generate returns for investors with hedging techniques. These funds have the flexibility to invest in a diverse range of assets such as stocks, commodities, currencies, emerging markets, and financial derivatives.

What do hedge funds do?

Hedge funds make profits and aim to reduce financial risks for their clients. What instruments do they use for it? Usually, they use options and futures for currencies, stocks, bonds, stock indices, commodities (such as oil, gas, grains, gold, and silver), and even real estate.

The most famous hedge funds in the world are Bridgewater Pure Alpha Hedge Fund, Renaissance Technologies (they use artificial intelligence and machine learning to achieve high returns), Bridgestone, BlackRock, Bridgewater All Weather, and Warrior Equity.

What techniques do hedge funds use?

Hedge funds use several techniques to reduce financial risks and generate returns for investors. Among the techniques, most used in hedging are:

Short selling. Funds are selling financial assets that they don’t currently own while betting on a decrease in the price of these assets in the future. 

Options. Investors buy an option to buy or sell a financial asset later at a specified price. 

Futures contracts. A futures contract is a contract that includes an agreement to buy or sell financial assets at a later time at a specific price.

Natural hedging. Funds diversify their investment portfolio with various financial assets, thus reducing the financial risks that the portfolio is exposed to.

What are the common hedge fund strategies?

Hedge funds use the techniques described above to form a hedging strategy. Though a strategy depends on the market they work in, the most common strategies include:

Cash Hedging. This strategy is used to hedge cash risks, where a percentage of cash is held to cover potential losses in the investment portfolio. Bridgestone hedge fund uses this strategy.

Options hedging. This strategy is used to hedge market fluctuations. Options are purchased to buy/sell financial assets in the future at a specified price, to reduce financial risks. Bridgewater Pure Alpha Hedge Fund and BlackRock rely on this strategy.

Futures hedging. This strategy is used to hedge price fluctuations. Futures contracts are purchased to buy/sell financial assets in the future at a specified price to reduce financial risks. It’s similar to options – learn the difference between them in our article.

Equity hedging. This strategy is used to hedge stock risks. Investments are made in stocks and related financial derivatives, using hedging techniques to reduce risks. Warrior Equity goes for this type of hedging.

Natural hedging. This strategy is used to hedge investment portfolio risks. The investment portfolio is diversified to include different financial assets reducing financial risks. Bridgewater All Weather uses natural hedging.

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