What is a Hedge Fund?
For many entry-level investors, hedge funds are shrouded in mystery and exclusivity.
It’s common, for example, for media coverage to focus on the ultra-wealthy founders and CEOs of hedge funds, such as Ray Dalio or Bill Ackman, as well as their secretive investing strategies or exclusive clientele. Like investment banks, they are seen as an elite fixture on Wall Street, and they also get scapegoated for a variety of market problems ranging from manipulation to a lack of transparency.
However, despite an image of complexity and secrecy, the basics around hedge funds are actually quite easy to understand. Today’s infographic from StocksToTrade.com highlights some of those key points.
Hedge Fund Basics
Hedge funds are generally structured in a similar manner to venture capital funds:
General partner: This partner is in charge of the fund, and invests capital based on the fund’s objectives.
Limited partner: This partner is an investor that supplies some of the capital. It’s worth noting that generally only accredited investors are allowed by the SEC to invest in hedge funds, as they are considered high-risk investments.
With the money from general and limited partners, the fund executes on its investing strategy. Hedge fund strategies can range from trading currencies with extreme leverage to using event-driven tactics such as taking activist positions in companies.
Other hedge funds, such as Renaissance Technologies, are known for their focus on trading using big data, AI, and machine learning – and for taking an outside approach to investing by hiring mathematicians, physicists, or other people with non-financial backgrounds.
It’s most common for hedge funds to use a “two and twenty” fee structure. Limited partners pay a 2% asset management fee, and a 20% cut from any profits generated.
Pros and Cons
Arguably, the biggest benefit of investing in hedge funds stems from the ability to partner with some of the world’s top investment managers, and to generate returns that do not correlate with the market. Hedge funds can help to diversify a portfolio – and when the general market is struggling, hedge funds using the right strategy can still provide a handsome return.
In terms of cons, hedge funds require investors to lock up money for extended periods of time, and also tend to charge significant fees. Lastly, the use of leverage can magnify small losses, and a lack of diversification within a given fund can lead to more concentrated losses, as well.
For more on hedge funds, see 48 key hedge fund terms every investors should know.
Opportunity Zones: Aligning Public and Private Capital
Opportunity zone funds (OZFs) can help the neighborhoods that need it most, while also providing significant tax benefits for investors.
Opportunity Zones: Aligning Public and Private Capital
At the end of 2017, a potential $6.1 trillion in unrealized capital gains was available for reinvestment.
Throughout the U.S., unrealized capital gains have significant tax implications with enormous potential. Unrealized capital gains occur when the value of an asset has gone up on paper, but has not yet been sold for a profit. Taxes are triggered once the asset has been sold.
Investors can offset or defer these taxes in a few ways, including one new strategy: investing in opportunity zones.
Today’s infographic from Bedford Funds explains what opportunity zone funds are, their core benefits, and their potential impact across the country.
What is an Opportunity Zone?
Opportunity zones are U.S. Census tracts whose citizens experience economic distress.
Originating in the 2017 Tax Cuts and Jobs Act, they offer the potential to connect long-term capital with low-income communities across the country to drive return and impact.
How are opportunity zones chosen? The initial base is low-income census tracts, which have:
- Poverty rates of at least 20%; or
- Median family incomes lower than 80% of the surrounding area
The state’s governor or chief executive then nominates up to 25% of these areas as opportunity zones. Nationwide, a total of 8,700 opportunity zones exist, and 7.9 million of the areas’ residents live in poverty.
Overall, 35 million people live in these opportunity zones. There are a number of disparities between opportunity zones and notional averages across key variables:
|Poverty Rate||Median Family Income||Education*|
*Adult with Bachelor’s degree or higher
It’s evident these cities could benefit from increased investment.
What is an Opportunity Zone Fund?
An opportunity zone fund (OZF) is an investment vehicle that provides tax benefits for private capital to help revitalize economically distressed communities. Both operating businesses and real estate are eligible for investment.
Many investor types may take advantage of opportunity zone funds:
- Corporations– Also includes partnerships
- Accredited investors– Defined as high net worth individuals, brokers, and trusts
- Nonresident foreign investors– Only on capital gains earned in the U.S.
- Retail investors– Through funds that have lower minimums, though options are more limited
In addition to their wide eligibility, OZFs have a number of potential benefits.
Tax breaks on capital gains can be organized into three tiers:
- Initial Tax Deferral– Once the previously-earned capital gains are channeled into a qualifying OZF, federal tax is deferred until December 31, 2026 or the date the investment is sold— whichever comes sooner
- Step-Up In Basis– 10% of the original capital gains will be excluded from federal taxes if an investment is held for five years
- Capital Gains Tax Exclusion– Federal tax on capital gains earned within the OZF is 100% eliminated if an investment is held for 10 years
All things being equal, OZFs realize after-tax outcomes that are over 40% higher than a standard portfolio investment. For example, the potential after-tax value of a $100 investment after a 10-year holding period would be as follows.
|Initial Investment||Net after-tax value|
|Standard portfolio investment||$76.20 ($100- 23.8% capital gains tax)||$132.36|
*Note: assumes long-term federal capital gains tax rate of 23.8%, no state income tax, and annual appreciation of 7% for both the OZF and alternative investment.
While it takes a few years to realize these tax benefits, OZFs have long-term horizons to encourage sustained investment with a lasting impact. The result is the potential for sustainable and equitable wealth creation.
Although real estate investments have captured significant attention, recent regulation has clarified that operating businesses are also eligible OZF investments.
By investing in businesses, OZFs can have a direct impact on economic growth and job creation.
Ultimately, OZFs have the potential to catalyze collective impact through their scalable operating company and real estate investments. Working directly with community leaders, OZFs can help drive long-term rejuvenation from within, versus gentrification from outside forces.
Opportunity zone funds are projected to raise $44 billion in capital designed specifically to invest in this future growth.
Bridging the Gap: Wealth Isn’t Just for the Wealthy
The UK has a financial adviser gap, leaving about 51 million adults without advice. Learn how wealthtech makes investing accessible for everyone.
In the UK, money is the #1 cause of stress—ranking above physical health, work, or family.
When people begin investing, they see immediate emotional benefits compared to non-investors. In fact, investors are 16 percentage points happier, and 23 percentage points more positive about their well-being.
However, only 37% of Brits hold market-based investments. So why aren’t more people taking steps to invest? Today’s infographic from BlackRock outlines the barriers people face, and how wealthtech can help address these issues at scale.
The Wealth Problem
A variety of hurdles keep people from taking control of their finances.
- Lack of Resources: 59% of Brits feel they don’t have enough money to invest.
- Lack of Knowledge: 39% say a lack of knowledge holds them back.
- Fear of Failure: 34% are afraid of losing everything if they invest.
All of these factors culminate in insufficient investing. In fact, 50% of the €26 trillion European wealth market is currently in uninvested cash, earning zero interest.
What’s the Current Solution?
Traditionally, investment advisers helped tackle these issues. However, investors have faced challenges accessing professional advice in recent years.
A shortage of UK advisers is a main contributing factor:
- There are only 26,700 advisers, who can service an average of 100 clients each.
- This leaves over 51 million adults without professional advice.
Among available advisers, many impose investment minimums or fees that create barriers for lower-income populations. Financial advisers charge an average of £150/hour, and half of all surveyed advisers turned away clients with less than £50,000 to invest.
With so many hurdles to overcome, how can Brits take charge of their investments?
A Modern Solution
Wealth technology—or simply wealthtech—helps address these issues at scale, offering four main digital-first solutions:
- Helps investors build better portfolios.
Gone are the days of rudimentary spreadsheets. With the help of algorithms and machine learning, investors can now automatically build sophisticated portfolios.
- Helps advisors scale their services.
The automation of time-consuming processes allows advisers to service more clients.
- Reaches more people.
Wealthtech is accessible for all, not just the wealthy. For example, micro-investing apps allow investors to make small, regular contributions without paying a commission.
- Modernises infrastructure.
Wealthtech updates old legacy systems with more streamlined, automated systems. As a result, paper-based processes are replaced with mobile transactions that can be done with the click of a button.
These benefits can be applied across various branches of wealth management.
The Wealthtech Ecosystem
Investors can choose one of three main paths, based on their level of knowledge and interest.
“Do It Yourself” Investing
Confident investors who enjoy managing their own money can trade securities through self-directed online platforms.
“Do It For Me” Investing
Novice investors can use platforms that execute trades on their behalf, such as micro-investing or robo-advisers.
“Do It With Me” Investing
For investors in the middle of this spectrum, certain platforms offer a hybrid of digital transactions and professional advice.
With a wide variety of solutions available, investing has never been easier.
It’s clear Brits are open to the shift: 64% say new technology would help them be more involved in their investments.
As wealthtech evolves, it will be seamlessly integrated into daily life as part of a holistic financial services offering. Traditional barriers will be broken down, empowering individuals to take charge of their financial future.
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