According to Redhead the term hedge funds have existed since 1949.During that period, the Sociologist, author, and financial journalist Alfred W. Jones created the first hedge fund structure with the aim of neutralizing the effect of market movement by utilizing trading strategies to achieve a positive return on investment whether markets are rising or falling. Jones balanced his portfolio by combined both long position in the equity market (Buying assets whose price he expected to increase) and short position (Selling short assets whose price he expected to decrease). Jones referred to his fund as being "hedged" to describe how the fund managed risk exposure from overall market movement. This type of portfolio became known as a hedge fund first fund of fund that utilized hedge funds was created in 1969 in Geneva.
Purpose of the statement
According to David Varadi (2001) defined that "A hedge fund is a fund that can take both long and short positions, use arbitrage, buy and sell undervalued securities, trade options or bonds, and invest in almost any opportunity in any market where it foresees impressive gains at reduced risk or
According to John H. Makin (2006), a hedge fund is a private investment company or pooled investment vehicle that are sold in private offerings primarily to "accredited" investors, specifically institutional investors and "high net worth" individuals". The fund is only opened for investment to a limited number and particular type of investors like institutions such as pension fund, university endowment and foundation.
According to Mitchel M (2010) explained that the retail investors are individuals or families investing their own funds, may manage their own investments without investment managers, directly investing through a brokerage account, bank saving account, government savings bond and /or certificates of deposits. They are normally trading on smaller amounts than institutional investors like mutual funds, pension funds, etc.
Lacey E (2003) stated that the investing styles are convertible arbitrage, fixed income arbitrage, equity statistical arbitrage, equity non-hedge, macro, short selling, emerging markets, fund of hedge funds, relative value arbitrage, equity market neutral, event driven, merger arbitrage, distressed securities and market timing. And the features of hedge fund are legal limited partnerships, limited liquidity, performance fees, leverage, secrecy, inflexible redemption/ subscription policies, restrictions on investor base, advertising, Unregistered, users of a variety of investment strategies and product such as option, future swaps and short selling.
The Hedge Funds are not suitable for retail investors due to the limitation drawn from features, regulation, strategies and structure that keep Hedge Funds away from retail investors and constrain the beneficiaries to the public, such limitation includes; is absence strict regulation, required high initial capital, lack of transparency, the fixed period which limits investors to draw money, returns based on the absolute returns and risk associated with dependence on the fund managers, therefore it is not advised for retail investors to invest in hedge funds.
Hedge Funds do not have the infrastructure and experience to service a large number of retail investors. Structurally, hedge Funds is opened to a limited number of people or classes of investors who meet the criteria set by regulatory are those who only newly accepted by the firm concerned. Hence it is not suitable for retail investors since it is marketing to sophisticated inventors only. According to Lacey, (2003), hedge funds cannot service a relatively large number of retail investors because they lack the experience and infrastructure to do so. Thus reform in the regulatory mechanism is needed to protect retail investors.
Hedge Funds Require a Huge Amount of Capital as Initial Investment. According to Spaulding, (2011) hedge funds are private investment partnerships that are exclusive to a small number of wealthy and sophisticated investors who are required a large initial investment. For example in US, hedge funds require $250,000 or $10,000,000 initial investments or more, an amount that small or retail investors cannot afford.
Hedge Funds work under variety of Legal restrictions and regulations. According to Franklin R. Edwards (2003) hedge funds are investment pools and are potentially subject to a variety of legal restrictions and regulations unless they are organized in a way that exempts them from these regulations. They obtain their investors though private placements rather than a public offering where retails investors are available in large number. Hence hedge funds are not suitable for retails investors.
Retail Investors Have Limited Capital to Invest.According to Tatum, n.d. (2006) Retail investors are small investors with a very small capital to invest. They only buy securities in smaller quantities or retail, thus called, retail investors. Retail investors purchase and manage their investment personally or through investments clubs and brokers. Retail investors invest less frequently compared to institutional investors although they sometimes earn by buying and selling at a daily rate through online trading mechanisms only the wealthy and the real hedge fund investors can afford to invest in hedge funds.
Investing in Hedge Fund is Profitable but Very Risky. According to Kovas, n.d. (2006) hedge funds are opening up to retail investors. But retail investors in hedge funds are still unprotected by regulatory bodies and invest at their own risk. Retail investors are presumed to have a lower level of sophistication in securities investing, with their very little capital, and very little asset, the risk is very much high for them. Due to the reason above, hedge funds are not suitable for retails investors.
Convertible arbitrage. According to Sharp F. (2007), The hedge fund use the strategy that concerned with the use of convertible bond which is so complex and bonds are quite complicated to understand because it need a fixed income instrument to convert the principle into common stock. Therefore in the market equilibrium where prices fully reflect available information, some assets have positive or negative alphas, returns from value stocks and small stock would be particularly poor in poor market, due to this case small and downtrodden investors are more likely to fail, hence not suitable for retails investors.
Global Macro (Exotic and International Strategies). According to David Varadi (2001) Macro funds invest on the basis of their views about international macroeconomic events. These funds tend to be more highly levered than average, and involve controlled speculation (invest in stocks, property) on investments such as currencies, interest rates, or on the direction of equity markets of a whole country. These macro bets are difficult if not impossible to hedge because of the lack of correlation between assets in their portfolios. Hence it is not suitable for retail investors.
Higher fees. According to Purcell et al, (1999), Retail investors may gain access to managers that were not otherwise available because of the high minimum investments. Generally, the research/studies have found that fund of funds have the lowest volatility of the hedge fund styles, and also have lower average returns due to the higher fees charge which have an additional of 1 to 3% on top of the fees charged by the underlying funds. Hence it is not suitable for retail investors because retail investors may not manage such high fees related to lower average returns.
Event Driven. According to David Varadi (2001) Event driven strategies encompass so-called "special situations" Other examples include merger/acquisition or risk arbitrage, where the manager purchases the shares of the company expected to be bought, and sells the shares of the acquirer. In this case the "risk" is that the deal will not go through as planned, which is much more significant in this case, since the deal has not yet been announced. Arbitrage returns in general tend to be quite small, and thus arbitrage funds tend to use leverage more aggressively than other Funds to increase returns. Since the risk of loss is often minimal, a near certain profit can be locked in. Thus the hedge funds are not suitable for retail investors since always investors prefer most to invest in the company that have high returns.
Fixed Income. According to David Varadi (2001) Bonds and mortgage-backed securities are typically the primary focus. Frequently, the managers have specialized knowledge of specific types of bond issues, with varying credit quality, giving them a decided edge in trading. The bonds in the same category that were selling at a premium to the fair yield were sold in proportion to the bonds bought. The general idea of course is for the bonds to converge to fair value, Retail investors may suffer a considerable loss as the bonds actually diverged due to an unpredictable turn of events as a result they will not having a expectable amount of fixed income.
Lack of Transparency.According to Jaeger, Robert. A. (2003), the hedge funds are not obliged to disclose their activities to third parties unless otherwise retail investor have to meet regulatory requirements for disclosure, therefore hedge funds are not suitable for retail investors since it has very limited transparency to investors.
Certainly hedge funds have aspects that are clearly good for retail investor as in the following.
According to Riley,B.(2000), Firstly, Hedge funds portfolios can provide a meaningful improvement in the risk-reward tradeoff for an investor, Hedge funds portfolios have produced risk-adjusted returns and alpha that are superior to traditional investments,
Secondly, hedge fund have low correlations with traditional asset classes means the asset classes has been low and therefore provide significant diversification benefits in portfolios.
According to Jaeger, Robert. A. (2003) Investors may be interested to hedge fund of funds means that a hedge fund that invests in other hedge funds. In this kind of hedge fund, retail investors are able to move money between the best funds in the industry, and thereby increase shareholders returns with more diversification.
According to Lacey, (2003) Retail Investors can either gain from or lose from hedge funds. Hedge funds relatively stable and significant over-all return, can improve the investment portfolio of retail investors. Knowledge of hedge fund trading and investment strategies also benefits the retail investor himself.
Conclusion
Conclusively, the explanations described above examined that the retail investors should not be advised to invest directly to hedge funds since they have very little capital, asset and experience to judge whether such an investment is appropriate for their investing needs. Mean while the features of hedge funds like Fixed Income, Event Driven, Higher fees, Global Macro (Exotic and International Strategies), Convertible arbitrage, Risky, wealthy (large capital), Legal restrictions and regulations, limited number of people or classes of investors and lack of transparency which gives more favorite to large capital investors. Moreover the hedge funds have little importance such as Hedge funds portfolios which produced risk-adjusted returns, low correlations with traditional asset classes, hedge fund of funds and diversification benefits to retail investors compared to limitation arisen to retail investors.
Recommendation
In order to make hedge funds suitable for retail investors, the hedge funds should operate under the following hints such as transparent to regulators and investors, operational and risk management standard in the industry and information sharing and cooperation between regulators, investors and managers of hedge funds.
