A hedge fund is an investment vehicle designed to generate consistent returns with low correlation to broad based indices. For those new to this world, it's beneficial to learn the industry terminology.
Hedge Fund Terminology Every Investor Should Know
Investing in hedge funds can be a complex and sophisticated endeavor. Hedge fund strategies can vary significantly, however they tend to share common terminology. Below are ten key hedge fund terms that every institutional investor should be familiar with.
1. Alpha
Alpha represents the excess risk adjusted return on an investment relative to the return of a benchmark index. It is a measure of a hedge fund manager's ability to generate returns beyond market averages through active management. A positive alpha indicates outperformance, while a negative alpha indicates underperformance.
2. Beta
Beta measures the systemic risk of a hedge fund relative to the market. A beta of one indicates that the hedge fund's price has moved in lockstep with the market. A beta of less than one means the fund has shared less systematic risk than the market, while a beta greater than one indicates more systematic risk.
3. AUM (Assets Under Management)
AUM refers to the total market value of the assets that a hedge fund manages on behalf of its clients. This figure indicates the fund's size, scale and investment capacity.
4. High-Water Mark
The high-water mark is the highest peak in performance valuation that a hedge fund has reached. It is significant because performance fees are only charged on new profits that exceed the high-water mark, ensuring that investors do not pay fees on the same profits more than once.
5. Hurdle Rate
The hurdle rate is the minimum rate of return that a hedge fund must achieve before it can charge a performance fee. It ensures that investors earn a minimum return before the fund manager takes a share of the profits.
6. Lock-Up Period
The lock-up period is the time frame during which investors cannot withdraw their investments from the hedge fund. This period allows the fund manager to invest the capital without worrying about short-term liquidity demands.
7. Redemption Notice Period
This is the amount of time an investor must give prior to withdrawing funds from the hedge fund. It allows the fund manager to liquidate assets in an orderly manner to meet redemption requests.
8. “2 and 20”
"2 and 20" is a historically common fee structure for hedge funds, where the manager charges a 2% management fee on assets under management and a 20% performance fee on any profits generated.
9. Drawdown
A drawdown refers to the decline in the value of an investment from its peak to its lowest point. It is used to measure the previous risk characteristics of a hedge fund.
10. Leverage
Leverage involves borrowing capital to increase the potential return on investment. While leverage can amplify gains, it can also magnify losses, making it a risk metric hedge fund investors monitor.
A partner you can trust
Understanding the industry terminology can provide a basis for understanding the salient characteristics of hedge fund investing.
Resonanz Capital works with the best hedge fund professionals available. We have a proven track record of successfully handling complex strategies. Our experienced hedge fund management process has produced substantial capital gains with low market dependence, while outperforming peers.
