Hedge funds pool funds from different sources to invest in a wide range of securities. Hedge fund managers can use stocks, bonds, derivatives and other securities and strategies to maximize returns. According to Frank Belvedere, former vice president at Montreal, Canada-based investment management firm Montrusco Bolton, net exposure measures the directional market risk of a hedge fund. A positive net exposure indicates vulnerability to market declines, while a negative net exposure means losses during market rallies.
Get a hedge fund's long position as a percentage of the fund's investments. Hedge funds are not required to publish investment details, although some managers might voluntarily disclose general ranges to the business press. Hedge fund investors should have access to this information. A long position refers to direct ownership of stocks, bonds, futures, options and other securities. Long positions rise and fall with the market.
Get a hedge fund's short position as a percentage of the fund's investments. Again, investors should have this information. A short sale occurs when a hedge fund manager or a regular investor borrows a security from a broker and sells it in the hope of buying it back later at a lower price, thus profiting from the difference. Therefore, short positions are unprofitable when the market rises, but profitable when the market falls.
Calculate the net exposure, which is the long position minus the short position. For example, if a hedge fund's long and short positions are 110 percent and 60 percent, respectively, the net exposure is 50 percent. Hedge funds can invest more than 100 percent of their assets because they can use leverage, which means borrowed money. Note that this formula assumes that the long and short positions are in similar securities.
Analyze the implications of the net exposure. For example, a hedge fund with a high positive net exposure, in which the long position is greater than the short position, could face significant losses during a sustained market downturn. Conversely, a fund with a negative net exposure, in which the short position is greater than the long position, would face losses in a long bull market.
Hedge fund managers usually receive a management fee and a performance fee. The management fee is based on the assets under management and the performance fee is a percentage of the hedge fund's profits.
- U.S. Securities and Exchange Commission: Hedging Your Bets -- A Heads Up on Hedge Funds and Funds of Hedge Funds
- Lindzon & Associates: Understanding Hedge Funds; Frank Belvedere
- SEC. "Implications of the Growth of Hedge Funds," Page 32. Accessed Nov. 6, 2019.
- Harvard Law School Forum on Corporate Governance. "The Activism of Carl Icahn and Bill Ackman." Accessed Jan. 9, 2020.
- Ican Enterprises. "Board of Directors." Accessed Nov. 7, 2019.
- Congress. "H.R.3606 - Jumpstart Our Business Startups." Accessed Nov. 6, 2019.
- SEC. "Hedge Funds – A New Era of Transparency and Openness." Accessed Nov. 6, 2019.
- SEC. "Proposing Amendments to Private Offering Rules." Accessed Nov. 7, 2019.
Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.