Patton Fund Management - About Hedge Funds

About Hedge Funds

Patton has several investment strategies incorporated into its various funds. These strategies range from a long-only to a pure dollar-neutral hedge and are built generally, and often exclusively, around U.S. traded equities. More information may be found on our Investment Strategies section.

What is a Hedge Fund

The term hedge fund tends to represent a pooling of investors’ capital into a fund that is managed by a manager. Most often these funds are setup as limited partnerships with each investor being a limited partner and the manager being the general partner.

Hedge funds are not new to the marketplace but instead have been around for more than 50 years. Hedge funds’ primary goal is to produce positive, absolute rates of return regardless of the returns of other investments such as stocks and bonds.

One of the great benefits of hedge funds is the lack of correlation to the stock market. The accompanying graph illustrates the performance of hedge funds during periods when stocks are up and during periods when stocks are down. Such performance can provide great benefits to a traditionally allocated portfolio of stocks and bonds.

Source: All Hedge Funds=Hedge Fund.net; S&P 500=Standard & Poor’s

Hedge Fund Styles

The nature of hedge funds lends itself to a great deal of flexibility when it comes to investment styles. As a result, investment styles can range from the very most conservative to the extremely aggressive. Assets in funds may include anything from stocks and bonds to derivatives and illiquid positions.

A true “hedge” fund is one that is hedging the risk of one investment with an investment in something else. The most common hedge in a hedge fund is one where stocks that are owned long (resulting in profits when prices rise) are hedged by stocks that are sold short (resulting in profits when prices fall). This results in potential profit regardless of the performance of the overall market.

The use of leverage has one of the biggest impacts on a fund’s risk profile. The use of leverage ranges from none at all to many multiples the investors’ contributed capital. Leverage is a common component in hedge funds and, if used diligently, can greatly enhance returns.

Hedge Fund Industry

The actual size of the hedge fund industry is unknown because most funds are not registered. In a recent study conducted by the Securities and Exchange Commission, it was estimated that there are currently 6,000 – 7,000 funds with assets totaling more than $750 billion.

Depending on the source, it is estimated that the hedge fund industry will grow by as much as 20-25% annually during the next several years. This will conservatively put the industry at $2 trillion in assets by 2010, up from less than $50 billion in 1990.

Investors in hedge funds include both high net-worth individuals and institutions. The SEC defines a high net-worth individual as a person with a TOTAL net-worth of $1.5 million and institutions as those with $5 million of investable assets. Some of the largest and most successful institutional investors have allocated as much as 40% of their total assets to hedge funds.

Source: 1992 = HFR, 2003 = SEC, 2010 = InvestmentAdvisor.com article