Hedge funds: Wading through the myths

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hedge fundsWhether it’s because of their somewhat questionable reputation in the past, or just due to the fact that hedge funds are proving to be such a popular form of investment, it would be fair to say that there are umpteen myths which surround this topic. The role of hedge funds is fundamental in most financial crises since the 1990s. In effect, the way in which the hedge funds work is as follows: with the money of several investors, who are the ones who create the fund, any financial product is bought, any of them. Once the money is revalued, the fund returns the initial investment to its owners, plus the corresponding interest. The bank or manager, who has carried out the operation, takes its commission, generally quite important. This type of financial activity is usually behind the financial crises that have been experienced since the 1990s. Thus, there is the case of George Soros who through his hedge fund managed to make the pound fall.

In fact, you could probably hone in on most financial markets and uncover plenty of misconceptions. It’s an industry which is dominated by information and as such, it stands to reason that not everything is accurate. Ultimately, for every truth from the likes of Kingstown Capital, there will be plenty of inaccurate information put out there by other sources. It means that some facts need ‘clarifying’.

Unfortunately, to clarify everything would take years. There are certainly some pieces of information which are documented more than others though and to highlight how hedge funds are affected, we’re going to run through some of these now.

Myth #1 – Hedge funds are too risky

Well, this is one myth that has been doing the rounds for years. For some reason, some sources often state that hedge funds are much riskier than other forms of investment.

Put simply, we’re here to say that this isn’t the case. This isn’t some sort of pie-in-the-sky answer either, with no blatant evidence, historic statistics show that hedge funds return higher averages than other investments.

Of course, ‘risk’ isn’t just about returns. When we also look at the volatility of this market, it’s much lower than others. Over the past two decades, the volatility of hedge funds has been around 7%. When you consider the fact that S&P 500 has been over double this – it’s a pretty concrete counter-argument.

Myth #2 – There’s a systemic risk concern with hedge funds

Staying on the topic of risk, this next myth is just plain wrong. The main reason is simple; there are barely any funds with sufficient assets that are going to make a difference to the entire market.

Countless academics and studies have proven this, hedge funds are ‘safe to fail’, so to speak.

Myth #3 – Hedge funds usually go bust

The story of Peloton in 2007 has led to yet more concerns amongst those who are considering investing in hedge funds. However, that particular failure has seemingly strengthened the industry as a whole and far fewer mistakes are now being made.

Additionally, we can again point to history. Studies have shown that around 10% of hedge funds will be shut down each year, but most of these happen to be quite small anyway. Regardless, 10% is still quite a small number considering how much ‘risk’ people seem to accredit to this type of fund.

Myth #4 – Hedge funds are designed to avoid tax

It would be impossible to discuss each and every tax repercussion linked with hedge funds through the scope of this article. To suggest that they are used to only avoid tax is bordering on the ridiculous though, particularly when there are some hard and fast facts proving otherwise.

If we turn to the UK market for example, which is naturally much smaller than the US, it’s thought that tax revenues generated from hedge funds and their professionals can topple $6 billion. With that, little else needs to be said.

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