Over the years, hedge funds have gained popularity due to their ability to generate alpha (excess returns earned on investment above the benchmark return when adjusted for risk) in dynamic markets. The key to success is having a solid investment strategy that can adapt to dynamic market conditions. In this blog, we will explore what is alpha, delve into various strategies employed by hedge funds to generate alpha returns, discuss the investment process, analyse the risks involved, and things to consider while selecting the right hedge fund. Whether you are an experienced investor or a beginner, understanding these strategies can help you make informed investment decisions and achieve higher returns.
Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 introduced Hedge Funds in India in 2012. They fall under Category III and constitute funds that employ diverse investment strategies and instruments targeting positive performance regardless of market conditions.
As per the regulations, only accredited investors can invest in hedge funds. The minimum size for investing in these funds is INR 1 crore per investor and an entire fund needs to have a minimum corpus of INR 20 crore. These guidelines make them ideal for high-net-worth or institutional investors. Additionally, there is risk attached to these funds which makes them suitable for aggressive investors with a high-risk appetite in pursuit of higher returns.
Alpha in investing world means the ability of an investment strategy to beat the market. Alpha is referred to as ‘excess return’ or ‘abnormal rate of return’ concerning a benchmark or an index. Alpha measures the return above the normal expectation based on the level of risk. It is also used as a simple measure of whether an actively managed fund outperformed the index such as Nifty 50 or Sensex. A positive value means outperformance, while a negative alpha means underperformance. A positive alpha of 2.5 means the stock has beaten the index by 2.5%.
The hedge fund investment process involves the following stages:
Investors assess a fund manager's track record, investment philosophy, and risk management capabilities before allocating capital.
Investing in hedge funds brings in higher returns but is commensurate with the higher risks attached to it. Some of the risks are as under:
One of the key ways to manage risk in hedge fund investments is through diversification. Another important factor in managing hedge fund risks is staying informed about the market and regulatory changes. This requires ongoing due diligence and monitoring of your investments.
Several factors can interact and influence the performance of hedge funds and investors should keep the same in mind before allocating capital to the selected Hedge Fund. Some of them are listed as under:
Ongoing monitoring and evaluation of hedge fund investments are essential. Investors should track performance, risk metrics, investment strategy adherence, and operational aspects of the fund. Regular assessments ensure that hedge funds continue to align with investment objectives and meet expectations.
Hedge funds are considered to be an alternative asset class that offers higher returns compared to traditional investments. Due to the nature of these funds, they could be an ideal alternative investment for large and institutional investors. It is important to note that each strategy carries its own risks and rewards, and hedge fund managers apply their expertise and insights to navigate these dynamic markets successfully. By adopting these strategies and adapting to changing market conditions, hedge funds strive to generate alpha for their investors. But the use of such concentrated investment strategies can lead to huge losses as well. Hence, investors should do thorough market research before going ahead with any investment decisions in hedge funds.
Want to stay at the top of your finances? Don’t forget to sign up!
Join the community of 2.5 lakh + investors and learn more about Grip, the latest financial knick-knacks and shenanigans that take place in the world of investing.
Disclaimer: This communication does not constitute advice relating to investing or otherwise dealing in securities and is not an offer or solicitation for the purchase or sale of any securities. Grip Invest Technologies Private Limited ("Grip", formerly known as Grip Invest Advisors Private Limited) is not registered with SEBI in any capacity and does not advise, encourage, or discourage its users to invest or not invest in any securities. Grip is solely an execution-only platform and does not guarantee or assure any return on investments made by you in any opportunities sourced by Grip and accepts no liability for consequences of any actions taken based on the information provided. Your investment is solely based on your judgement. Investments in debt securities are subject to risks. Read all the offer-related documents carefully.