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Female hedge fund managerEvery investment class needs someone to manage it. From the market makers and clearing houses that ensure stock trading to the bankers who move currencies around the world, markets are not natural phenomena. They require management. Perhaps nowhere is that more true than in funds. A hedge fund, like similarly structured mutual funds and exchanged-traded funds (ETFs), is created and managed by a team of professionals who try to maximize its value. Crucial to that process are the analysts that do the ground-level work to select the hedge fund’s specific investments and assets. Here’s what they do.

Whether you’re a newbie or a seasoned trader, a financial advisor can provide customized insight into how best to reach your goals.

What Is a Hedge Fund?

While most investors will probably have heard of a hedge fund, not many people can actually invest in them.

Like any other fund-based asset, a hedge fund is portfolio based. A firm will create a hedge fund out of a bundle of assets. Performance is based on the overall return of the assets this investment portfolio holds. Investors can buy shares of this fund and collect returns proportional to their overall ownership. In turn, the hedge fund uses the pooled resources of its investors to make further investments and (ideally) grow the fund.

A hedge fund differs from more standard portfolio products such as mutual funds and ETFs in that they are generally much more aggressive than a standard fund product. A hedge fund may hold a wider variety of assets than something like a mutual fund, and may also hold assets which are higher risk and more exotic. This gives hedge funds greater opportunity for growth but also makes them riskier than most fund-based products, which are typically managed around stability.

Hedge funds can trade in just about any product on the market. Originally they were organized as portfolio products that held both long and short positions in stocks. The name “hedge fund” came from this practice of “hedging” a short position with long stocks or vice versa. Today a hedge fund may invest in short positions, derivatives, bonds, junk bonds, real estate, private equity and any other legitimate investment. Hedge funds ultimately trade in whatever a specific fund’s managers think will make a profit.

The practice of hedging the fund’s high-risk positions with offsetting and countercyclical assets remains common.

Individual hedge funds are generally organized around their trading strategy; for example, a specific hedge fund might invest in real estate, short positions or buying private companies. However, as an asset class they have little of a coherent theme other than that they seek outsized, active returns. Rate of return is important, as hedge funds typically emphasize active payouts to their investors over long-term capital gains.

For this reason hedge funds are limited to accredited investors only. These are high-risk products that often trade in high-risk assets. The specific investments in many hedge funds are themselves limited to accredited investors, so fund managers aren’t allowed to get around that requirement by packaging those restricted assets into a portfolio.

What Is a Hedge Fund Analyst?

Digital candlestick price chart

A hedge fund analyst finds individual assets for the hedge fund to trade, and a given analyst will focus on the specific areas that their fund specializes in. For example if an analyst works for a fund that invests in corporate debt, they will search for debt-based assets to include in the fund’s portfolio. Their research emphasizes the fund’s overall objectives, meaning that in most hedge funds an analyst will look for investments that maximize active returns.

Typically someone with a background in business, mathematics, finance or a substantially similar field, the analyst is an overwhelmingly quantitative position. They emphasize the numbers, reviewing any given asset for factors such as risk, potential rate of return, historic volatility and other metrics to determine whether a specific investment should be included in the hedge fund’s portfolio of assets. Hedge fund analysts rely on the formulas that define modern investing, such as the Capital Asset Pricing Model, to do their work.

Most of a hedge fund analyst’s work is based on extensive mathematical models. When an analyst finds a likely investment, it is based on how his or her formulae describe the likely range of risks and returns.

Analysts also study their markets as a whole in order to find likely investment opportunities. Their work may also involve extensive personal networking, industry research and fundamental analysis based on a given hedge fund’s specialty. For example, if a fund specializes in real estate its analysts may develop contacts among developers who can alert them to new developments. They may look up the nature of individual land deals, stay abreast of local politics and even visit the property itself as part of their research.

While this is a fundamentally mathematical position, the work that an analyst does can range widely.

Finally, hedging risk is also a crucial part of the analyst’s job. They are equally responsible for making sure that the assets they find perform well. This means that a hedge fund analyst doesn’t just find new assets, they are also responsible for monitoring the existing assets in a fund’s portfolio. They look for assets likely to lose value in the future, ones which the fund should divest itself of going forward.

What Does an Analyst Do?

A hedge fund analyst

A hedge fund analyst is one of the lower-tier members of a hedge fund’s investment team. In a typical hedge fund, the analysts do not make trading decisions themselves. Instead, when a hedge fund analyst believes that they have found a good investment they will pass that recommendation to the fund’s portfolio managers. Similarly, if they feel that they’ve found a weak investment that the fund should sell, they will pass that recommendation along as well.

In a typical hedge fund the managers decide whether to include any given asset in the portfolio. With a securities-focused fund this, too, is typically based on a series of mathematical models and algorithms. In a less analytical fund, such as one which invests in private companies, the decision may involve far more personal judgment. However, regardless of the nature of the fund, its management team has the final say.

If the fund manager agrees to include the new asset in the fund’s portfolio, they give instructions to the hedge fund’s trading team to execute the necessary transactions. This stage can also range in complexity depending on the nature of the fund. A stock-based fund, for example, may simply execute a series of buy and sell orders. A real estate fund, on the other hand, may enter negotiations to buy a piece of property while a venture capital fund may reach out to the leadership team of the company they’d like to acquire.

The Bottom Line

Hedge funds are portfolio-based investments built out of a collection of assets. A hedge fund analyst is the person who finds new investments for the fund to buy and identifies weak investments that the fund should sell.

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Photo credit: ©iStock.com/gpointstudio, ©iStock.com/metamorworks, ©iStock.com/celsopupo

Eric Reed Eric Reed is a freelance journalist who specializes in economics, policy and global issues, with substantial coverage of finance and personal finance. He has contributed to outlets including The Street, CNBC, Glassdoor and Consumer Reports. Eric’s work focuses on the human impact of abstract issues, emphasizing analytical journalism that helps readers more fully understand their world and their money. He has reported from more than a dozen countries, with datelines that include Sao Paolo, Brazil; Phnom Penh, Cambodia; and Athens, Greece. A former attorney, before becoming a journalist Eric worked in securities litigation and white collar criminal defense with a pro bono specialty in human trafficking issues. He graduated from the University of Michigan Law School and can be found any given Saturday in the fall cheering on his Wolverines.
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