In the financial market, a hedge fund is an investment technique that aims to maximize returns while simultaneously implementing strategies to avoid or reduce risks. Although it promises high returns, it also involves high risks, and is predominantly managed by wealthy individuals and institutional investors rather than the average investor.
The word ‘hedge’ originally means a fence or boundary in English. In finance, it is used as a conceptual ‘insurance’ to protect against unexpected losses. For example, an investor holding a particular stock may anticipate a decline in its price and may counteract by short-selling the stock or selling stocks in the same sector. This structure aims to offset potential losses through other assets.
Hedge funds originated from these risk-avoiding strategies but have evolved into complex investment structures with high-risk, high-return strategies. Unlike standard public mutual funds, hedge funds raise money privately from a small number of investors and can freely invest in almost any asset, including stocks, bonds, derivatives, foreign exchange, commodities, and real estate. Due to their pursuit of profit through various financial techniques, they are also known as ‘absolute return funds.’
Key strategies include market-neutral long-short strategies, arbitrage, global macro, event-driven, and high-frequency algorithmic trading. For example, there is often a price difference between the acquisition price and the market price for companies slated for mergers and acquisitions. Hedge funds exploit this difference by buying stock in the target company and selling stock in the acquiring company to pursue profit, known as ‘risk arbitrage.’
In Korea, the hedge fund market began to form in earnest following the permission for private equity funds in 2004. Since 2015, various hedge funds have emerged under the title ‘Professional Private Investment Fund’ as the financial authorities laid down an institutional framework. The minimum investment amount is over 100 million won, and only investors with a deep understanding of finance can participate.
In the global market, Bridgewater Associates and Renaissance Technologies are notable examples. These funds make investment decisions using macroeconomic trends, statistical models, and artificial intelligence algorithms, aiming to generate profit independent of stock price movements.
However, if the risk materializes, the losses can be significant. In 1998, the U.S. firm LTCM (Long-Term Capital Management) suffered huge losses due to bond arbitrage with excessive leverage, causing such market turmoil that the U.S. Federal Reserve had to intervene. The 2021 case of Archegos Capital is a similar example, where aggressive derivatives trading led to multi-billion dollar losses for global financial firms.
While hedge funds are built on a high-risk, high-reward structure, their essence lies in pursuing profit while managing risks. ‘Hedge’ is not merely a defensive measure but a technique for designing a balance of profits and losses. Only investors who fully understand and can manage the structure, strategy, and risk factors can effectively utilize this complex financial product.
