o3 BLOG | Investing

Hedge Funds and The Gold Market

January 5, 2022

O3 Mining

Hedge funds are privately managed investment pools that use long/short funds to buy and sell stocks, engage in arbitrage, trade bonds, currencies, convertible securities, commodities, and unlisted derivative products. Long/short funds aim to supplement traditional long-only trading by profiting from securities identified as both under-valued and overvalued. Short hedging is often used in commodities markets, such as gold and other precious metals. As the name implies, the purpose of a hedge fund is to mitigate the risks to investor capital posed by market volatility through the use of alternative investment strategies.

 

Who Invests in Hedge Funds?

Hedge fund investors are often high net worth individuals, wealthy families, pension funds, endowments, insurance firms, banks and other institutional investors. Unlike the United States, which has one regulatory body — the Securities and Exchange Commission (SEC), Canadian hedge funds must register with the province or territory they will operate in and adhere to national regulatory guidelines set out by the Canadian Securities Administration (CSA).

As many hedge fund managers provide investment advice, they must also register as financial advisors. Portfolio managers that sell securities must register as dealers and ensure that they register in each province or territory where they plan to offer the fund. Ontario is currently the leading jurisdiction in Canada for registering hedge funds and the oversight of managers.

A hedge fund can earn returns using a variety of tactics. Specializing in global macros is one strategy in which the fund takes long and short positions in broad financial markets based on economic patterns. Some funds pursue a market-neutral strategy. In this case, the fund manager’s purpose is to reduce market risk by investing in long/short equity funds, convertible bonds, arbitrage funds, and fixed income products.

Another form is event-driven funds, which invest in equities to profit from price changes caused by corporate events. This category includes merger arbitrage funds and distressed asset funds.

Gold Market Hedge Funds

Some hedge funds specialize in the gold market, where the fund directly benefits from the price increases in gold. However, a hedge fund is as successful as the team that manages it. Successful hedge fund managers are well-versed in portfolio management and several other critical areas, namely economics and finance. A gold hedge fund manager must also know about the precious metals market and have a solid understanding of what may be driving the prices of precious metals and other market-specific considerations.

Hedge fund strategies are typically based on the needs of the investors and the investing team’s approach. The strategy’s ultimate test may be how well it succeeds in real-world market situations. One of the main benchmarks for gold hedge funds is gold itself, where the returns of a gold hedge fund correlate to the returns on the yellow metal. Another possibility is to compare the performance of gold hedge funds to the risk-free rate. In other words, the question in this circumstance is whether or not a specific gold fund is profitable.

While the primary focus of investing is usually the return on investment, there is some risk involved, just like any asset category. A combination of risk and return measures can produce metrics showing how well funds performed in relation to how stable their returns were. The Sharpe ratio is a standard metric in this area. Over a given period, funds with higher Sharpe ratios outperformed funds with lower ratio values in terms of both returns and stability. Seasoned fund managers should see the bigger picture, aiming to make profits without excessively volatile fund returns and to exceed the traditional buy-and-hold approach. Gold hedge fund managers can improve the risk-return characteristics of your gold portfolio, for example, generating higher returns with less volatility, even after fee deductions.

Another advantage of gold hedge funds is that they eliminate the need for you to monitor the market continually and can ease some of the anxiety that strikes when you see your portfolio value decrease intraday. One of the primary purposes of a hedge fund manager is to provide you with more peace of mind than you would have if you traded and invested on your own.

Hedge funds often use the “2 and 20,” structure which implies that the fund charges 2% of the fund’s assets annually (annual management fee) and 20% of the fund’s profits (performance fee), which, in turn, impacts the fund’s after-fee performance. Performance fees are basically the manager’s cut for making you (a LOT of) money. The annual management fee covers any costs associated with running the fund, including establishing a fund and legal fees.

These expenses have an impact on the fund’s after-fee performance. When selecting a gold fund, consider whether the fund offers value in the sense that it can increase the risk-return characteristics of your investment or that it provides you with the peace of mind that you cherish. The performance fee appears to be self-explanatory – it is the fund’s “reward” for making money. The annual management fee ensures that the fund can cover various running costs such as the price of establishing a fund, legally mandated fees, software licences, and other expenses.

Things To Consider When Investing in Gold Hedge Funds

As we mentioned earlier, hedge fund investors are either institutions or wealthy people, making sense that they are expensive. Fund managers need a lot of money to make money so that the hedge fund stays in the black. Investment amounts usually start in the low six figures, making hedge fund investing inaccessible to individual investors.

Bottom Line:

Whether or not a gold hedge fund is right for you might depend on finding the right fund manager. Perform your due diligence and keep an eye out for hedge fund managers with successful track records that can outperform the buy and hold gold technique in terms of return on investment and risk. With a sound investing plan and substantial capital to commit, gold hedge funds may turn out to be another comfortable way of investing in the gold market. 


To learn more about alternate investing, contact the O3 Investment Relations Team!

 

Sources:

https://www.sec.gov/files/ib_hedgefunds.pdf

https://www.securities-administrators.ca/news/canadian-securities-regulators-implement-eight-initiatives-to-reduce-regulatory-burden-for-investment-funds/

https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/global-macro-strategy/

https://web.stanford.edu/~wfsharpe/art/sr/SR.htm

https://www.investopedia.com/terms/t/two_and_twenty.asp

 

To learn how O3 Mining can add long-term value to your portfolio, contact us today.

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