Hedge Fund Risk Fundamentals: Solving the Risk Management and Transparency Challenge

CHAPTER 10

Constructing a Fund

Webster's Dictionary defines “hedge fund” as “an open-end investment company organized as a limited partnership and using high-risk speculative methods to obtain large profits.” The dictionary separately describes “hedge” as “to enter a transaction intended to protect against financial loss through a complementary price movement.” How can one reconcile the apparently conflicting concepts of “speculation” and “protection” in hedge funds?

The unfortunate answer is that there is no such thing as “a” hedge fund, so the concepts cannot be reconciled. If you profile the world of private investments, approximately 97 percent of funds are invested in equities, bonds, or cash equivalents (see Figure 10.1).

The balance is ...