What is a Mutual or Hedge Fund and what does a Fund Manager do?

To describe what does a Fund Manager do, we need to explain first of all what is a Fund and the difference between Mutual Funds and Hedge Funds.

A fund is a pool of investor money managed by a professional Fund Manager. The Fund Manager is responsible for finding investments that suit the funds’ objective. The profits from the investments are shared among those who have contributed to the pool of money.

The most common type of investment partnerships is Mutual Funds. They invest in publicly traded securities (stocks & bonds), and anyone is allowed to join. To protect general public investors, Mutual Funds are heavily regulated and restricted in what they can invest into.

Due to various scams in the 1920s and 1930s, US fund industry is strongly regulated to protect the investors’ interests. Various safety measures protect the common investors, but they also limit the potential returns for investors with a high tolerance for risk. In the 1950s, a new type of fund was introduced (and become quite popular since 1980s) that were suited for the wealthy investors with a high level of risk tolerance. These are the hedge funds.

Hedge Fund is an investment partnership restricted to “sophisticated investors” – people who have enough experience to protect themselves. Hedge Funds are not allowed to accept capital from the general public; in exchange, they don’t have restrictions on what they can invest into.

what does a fund manager do

Fund Managers are the partners designated to make investments and manage the partnership; for their work, time and efforts they receive compensation with a share of the money. Unlike Mutual Fund Managers who receive only fixed fees, Hedge Fund Managers also receive a share of fund profits as a performance incentive. Profit sharing aligns interests of managing partners and investors better and attracts the top talent to Hedge Funds.

For this reason, Hedge Fund Managers typically take unorthodox positions and investment strategies, markets, and investment vehicles that are not used by traditional long-only mutual Fund Managers, like:

  • Arbitrage: Identifying patterns that result in temporary mispricing in the market and get onto it before somebody else could find.
  • High-frequency trading during events. They use very advanced data analysis tools to make a trade milliseconds after the occurrence of an important event such as an interest rate change or a merger announcement.
  • Distressed investments: investing in companies in difficult situations.
  • Short selling a stock: buying good/cheap and shorting bad/expensive stocks; this way you could benefit in a market that is falling.
  • Use of derivatives. This allows a more fine-grained management of risk.
  • Alternative Investments. These could include oil, precious metals, silver mines, small-cap in BRIC markets and so on.
  • Strong focus on timing. Hedge funds use a lot of quantitative tools to precisely time their entry and exit.
  • Emerging Markets: investing in developing countries like India, China;
  • Market Neutral: making portfolios insensitive to market fluctuations;
  • Global Macro: investing in global economic trends.

Due to this, they tend to display non-linear returns, risk and correlation characteristics that make them a good candidate for both investment and diversification purposes.

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