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What is a Hedge Fund

Sunday, March 21st, 2010

As the name of this financial terminology implies, these particular financial instruments or funds are available to investors for the purposes of hedging against the risk and potential losses that can occur from other riskier investments. These use a variety of techniques including other financial derivatives and the practice of short-selling what you have invested in prior. They typically involve a broader range of investment or share-trading activities over and above what other long-term investment instruments provide you with.

Ironically, hedge funds can be utilized can be employed to increase the risk factor. In other words, they do not help to hedge the investments, especially where hedging methods such as short-selling are concerned. Instead, they increase the risk factors involved in order to increase the potential of a better ROI (return on investment). These use other hedging methods such as short-selling to increase the risk to hopefully encounter a positive gain on their investment.

Typically, hedge funds are only available to those professional and wealthy individuals that meet certain regulation criteria. However, in exchange for this, they are exempt from ordinary investment funds regulations. These regulations usually include fee structures, leverage, liquidity of fund interests, short sale restrictions and the use of derivatives.

Additionally, lighter regulations and fees based on the performance of the fund are two characteristics that distinguish hedge funds from other investment funds. Where the net asset value of a hedge fund is concerned, it can run billions of dollars whereas the gross asset value can go even higher when leverage is employed. Certain specialty markets are dominated by hedge funds. An example of one of these is the trading within derivatives that have distressed debt and high-yield ratings.

In 1949, Alfred W. Jones (author, financial journalist, and sociologist) created the first recognized hedge fund. Jones was a firm believer of the concept that price movements of a particular asset or fund was determined by two key components. One component was the overall market while the second component was the asset’s actual performance record.

In order to balance his portfolio, his basic philosophy for neutralizing the effects of the market’s overall movement included two key points. 1. Purchase only those assets that are expected to have a stronger performance than the overall market and 2. Short sale all those assets that are expected to show weaker than market performance levels

Utilizing this philosophy, Jones witnessed the fact that the effect of the overall price market’s movements were canceled out. If the market rose overall, the shorted asset losses would be canceled by virtue of the gain encountered with the assets that were purchased and vice-versa. The purpose is to hedge that part of the investment associated with the overall market’s movements.

Finally, due to the lack of statistical information, it is difficult to estimate how large the hedge fund industry is. Additionally, a single definition of what a hedge fund is and how rapidly the industry has grown make accumulating any statistics very difficult as well. It is estimated that when hedge fund values peaked during the summer of 2008, that they were worth in excess of $2.5 trillion.

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Are Annuities Right For Every Investor?

Sunday, January 10th, 2010

Annuities are more of less alternatives or supplements to pensions and are used by investors when they are not working and in retirement to keep them financially stable and secure. But are annuities right for every investor?

Well, the answer to this is difficult to answer, and of course there are other options that any investor can take on. It really depends on what the individual investor is looking for and what their investment needs and objectives are.

For anyone who is nearing retirement, an annuity can offer them the financial security that they are going to need when they are not working. On the other hand an investor who is looking to actually make a significant return from their investments annuities may not be ideal and there are many different opportunities that they could take on which will offer up a much greater return on their investment.

When it comes to those retiring, however, an annuity is a very good investment option. What they are are essentially contracts made between an investor and an insurance company whereby the investor will input money over time or in a lump sum which will be able to accumulate additional interest. The investor will then get regular payments from their pot over time at intervals, usually of about a month.

Under the plans for most guaranteed income annuities the investor needs to be at least 59 years and 6 months old before they are able to start getting their contributions back and this is why these are designed for those coming into retirement and not for a younger investor who is looking to make a large amount of return from their investments.

When it comes to investing into an annuity, there are lots of different types that can be used such as variable, fixed, and immediate annuities so it’s important to understand what you’re getting in to and be sure to understand the terms like how many fees you will be paying and what the terms are for you to sell annuities if you don’t feel they are appropriate for your portfolio. Some will have a low base rate of interest that will slowly accumulate and are subject to market conditions, whilst others will be able to allow an investor to save more aggressively for retirement.

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Bonds vs Money Market

Tuesday, December 22nd, 2009

An overview of bonds and money market securities

What you want to consider first and foremost is that bonds and money market securities are both financial vehicles that are labeled as “debt instruments.” However, they are different types of investments. They are basically different based on the following:

  • issuance of new securities
  • length of time it takes each of them to reach maturity
  • the interest rates which are paid
  • the way in which the interest is earned on each
  • their relationship to changes in interest rates

Another fact to consider is that bonds will mature in 5 to 30 years, depending on the type of bonds they are, whereas money market securities typically mature over a period of 9 months or less.

How interest is earned and paid

Bonds are usually issued with a clearly stated interest rate which and interest is typically paid on a semi-annual basis. On the other hand, money market securities will normally be issued at a discounted rate towards their final maturity value. The key difference is what the investor is going to earn for holding to these until they actually mature. Another difference is that lengthier maturity periods tend to discourage investors because they are looking for a much greater ROI when investing for the long haul.

Ironically, the interest rates paid on most bonds is typically higher than those of money market securities. This is primarily due to the higher levels of inflation risk and the uncertainty that it breeds with money market securities. This aspect is in reference to what is called a “yield curve” and there have lengthy yield curve time periods that were inverted throughout history. This refers to periods of time where there are only inflation risks which are short term in nature which had been perceived to be higher and where the long-term risks were considered to be relatively low or stable.

The relationship to changes in the interest rate

For the most part, there is what is commonly called an inverse relationship between money market securities and:

  • being discounted when they are issued to the rate that investors should receive when they mature
  • changes in interest rates
  • maturity time frames that are considered to be short-term
  • there is a lower volatility in market value compared to changes in the interest rate

    • A bond’s market value will normally display an inverse relationship to longer-term-of- maturity bonds and are typically more volatile than bonds that have a shorter maturity term. The major advantages that you have when investing in money market securities versus bonds is the fact that your money is readily available should you want to withdraw those funds.

    The key disadvantage with money market securities is that they have lower rates of interest so the ROI is considerably smaller than with bonds. Conversely, the main disadvantage with bonds is that you will need to wait a full year before you can withdraw funds. Additionally, you will most likely be penalized three months of interest for withdrawing funds early with bonds during the first 1 to 5 years.

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    Are Treasury Bonds a Good Investment?

    Saturday, October 17th, 2009

    For all practical purposes US Treasury bonds are viewed as being financing instruments of the Federal Government and are oftentimes referred to as US savings bonds, though that is somewhat erroneous. Despite the fact that they are a near risk-free investment and pay better interest than a standard passbook savings account, they have lost some of their luster over the past few decades. From a historical standpoint, US savings bond came into being in order to finance the US Military Forces during World War I.

    8 key advantages of treasury bonds

    The popularity of US Treasury bonds stems from the many advantages they have for the long-term investor who wants to eliminate as risk as possible. These advantages include:

  • Treasuries are a low risk, relatively safe investment
  • The treasuries market is one of the world’s most liquid fixed-income market
  • Dealers make a profit by purchasing them at a lower price than what they earn once they have reached full maturity
  • Immediate price dissemination and liquidity provide investors with immediate knowledge of the bonds’ value
  • US Treasury bonds can be purchased and sold electronically
  • The interest on these bonds is not subject to local or state income tax even though they are subject to federal income tax
  • Unlike the majority of other bonds as well as other mortgage-backed securities, US Treasury bonds cannot be redeemed prior to reaching their maturity date
  • Treasuries are excellent loan collateral based on their high-credit liquidity and quality

    • What are the disadvantages?

    Despite the 8 key advantages listed above, there are two disadvantages to be aware of:

  • US Treasury bonds offer a relatively low YTM or Yield to Maturity
  • They are subject to huge political risk factors because the US
  • Government can print as much money as they see fit in order to avoid defaulting on financial debt
  • Where the higher risk and long-term investor is concerned, US Treasury bonds do not appeal to many investors

    • Are Treasury Bonds Worth Investing In?

    For the individual that is looking for an investment which is literally risk-free and doesn’t mind the lower YTM (see above), US Treasury bonds are great investments. However, if you are a risk taker seeing high ROI, then this may not be the financial instrument you want to invest in. Additionally, most of the US savings bonds that have been issued since 1965, they earn interest for a period of 30 years while eventually reaching maturity.

    Another plus is that they can be purchased relatively easily and can even be part of your employer’s payroll retirement or savings plan. US savings bonds currently pay 5.68% interest, roughly 90% of the average interest rate of US Treasury bonds. If that current rate of interest were maintained, today’s bonds would reach their maturity (face value) roughly 12 years. Suffice it to say, for those investors whose primary priority is protecting their investment and principal, these types of bonds have tremendous appeal.

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    Best Investments for Inflation

    Saturday, September 19th, 2009

    Protecting your investments from inflation

    From the standpoint of history and inflationary cycles, you should already be planning on protecting your investment portfolio from this. Educating yourself so that you gain a basic understanding of both good and bad inflation cycles is your best first move. It is also the best move that you can make in order to create other investments to protect your current ones in your portfolio.

    How to hedge against inflation with your investments

    Given the current economic state that the world is in, most people will go to great lengths in order to protect their investments from inflationary trends. Unfortunately, the decisions that many investors make are not always the smartest ones. Here are 3 investments to consider should you want to protect your investment portfolio:

    Corporate Inflation-Adjusted Bonds – this is one of the most recommended ways of hedging against inflation and is considered a better option rather than investing in TIPS (see the section below). Marilyn Cohen, the Forbes.com Bond Guru, stated in an article that corporate inflation-adjusted bonds are 0.4 percentage points higher than “A” rated US Treasury bonds. Additionally, since the risk factor is small enough, these types of bonds are highly recommended by numerous financial planners and investment analysts.

    Real Estate Investment Trusts (REIT) – REIT’s are pronounced “reets” and operate under the same premise that the value of commercial property rentals and leases typically increase when inflation is on the rise. These are companies that collect commercial property rental and/or lease payments. In addition to this, if you combine REIT’s with ETF’s (Exchange Traded Funds) and mutual funds, these protect your investments extremely well against increasing inflation rates.

    You should consider spending some time investigating and researching how REIT’s can help protect your investment portfolio against rising inflationary rates. Be thorough in your research, especially if you are considering doing any online investing. Another consideration is that you don’t want to sink all of your available investment funds in this one particular type of inflation-protected investment. REIT’s will still be a viable option for your investment portfolio and will ensure that your retirement nest egg does not get depleted despite what the economy may be doing.

    Treasury Inflation-Protected Securities (TIPS) – these are types of US savings bonds that were first issued in 1997. As these bonds are issued by the US Government they are almost risk-free and highly rated for that reason. Despite what inflation is doing to the economy, it has no effect on the value of these securities. TIPS assure you that your investment’s values do not suffer as inflation rates increase.

    Therefore, you are able to secure yourself against any financial loss when investing in these securities as well as avoiding a loss of financial power. Just keep in mind that as the value of the bonds increase, you are subject to more tax consequences. It is oftentimes recommended by financial planners that your portfolio should be comprised of 10% to 15% of these types of securities.

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