How does a hedge fund work?
Hedge funds are very similar to unit trusts, but apply a number of different strategies to mitigate the effect of market volatility. The most common hedge fund strategy in South Africa is referred to as “equity long/short”.
If the fund manager chooses to go “long”, this means that he or she will buy a share or a bond and then hold it with the hope that it will increase in value.
If the manager chooses to go “short”, it means that he or she doesn’t actually buy the share or bond, but “borrows” it from another investor and sells it.
The expectation in this scenario is that the price of the share or bond will drop. When that happens, the manager can then buy the share or bond at the cheaper price and return it to the original investor he or she “borrowed” it from, which means the manager makes a profit on the difference.