gold investment, silver investment

Precious metals investment terms A to Z

Gold Hedge Fund

Some hedge funds specialize in the gold market and in this case, one can benefit from both: gold's price gains, and portfolio manager's abilities. Naturally, there are some drawbacks as well, such as the fee that the fund charges.

Gold Hedge Fund - General Idea

In short, the idea is to have someone else manage your gold investments, perhaps because you don't have time to do so, or the necessary experience. The person managing the portfolio would use their knowledge to increase your profits and you would share a part of the profits with them.

Gold Hedge Fund Strategy

The strategy of the gold hedge fund (how the fund’s gold portfolio is managed) is certainly one of the most important of its aspects, second possibly only to the people that run the fund. Various funds tend to employ different kinds of strategies. Some funds might be purely fundamental, other purely quantitative. There are also mixes of these two approaches. The type of the strategy itself might not be as important as its details and execution, and this is where the people responsible for the fund usually leave their touch. Various strategies might be reasonable depending on the needs of investors and the approach of the investment team.

The ultimate test of the strategy might be how it performs in real market conditions. The performance might be measured over a specific period of time in absolute terms, telling us what kind of percentage return the strategy had, or in relative terms, comparing the performance of the strategy to a previously-chosen benchmark. For gold hedge funds, one of the possible benchmarks is gold itself. If this benchmark is chosen, we compare the returns of a gold hedge fund to the returns on the yellow metal. Another idea is to compare gold hedge fund’s performance to the risk-free rate. In other words, in this case the question would be if a given gold fund is making profits or not.

Returns tend to be a major focus of the investment public but risk is just as important. Currently, the most popular way to measure the risk is in terms of the standard deviation of returns. This measure shows you how much the returns have tended to change over a specific time horizon. The lower the measure, the less variability there has been and the more stable the returns of the strategy have been. This kind of approach to risk is subject to serious limitations since the standard deviation is a backward-looking measure and low levels in the past don’t necessarily have to persist into the future (think low standard deviations in 2006 and the subsequent explosion of volatility in 2008). Other measures used by hedge funds include the maximum drawdown (what was the deepest decrease in portfolio value, peak to bottom) and the maximum drawdown duration (how long did it take the fund to recover from the maximum drawdown to new highs).

Risk and return measures can be combined to yield metrics that give you information on how well the fund performed relative to the how stable it returns were. One of the most popular measures here is the Sharp ratio. Funds with higher Sharp ratios enjoyed a more favorable combination of returns and stability than funds with lower ratio values over a specific period of time.

While choosing an investment strategy or a gold fund it’s important to look at the metrics we’ve discussed above but also to check whether the employed investment strategy is actually sound. It is possible to get high returns and favorable risk metrics by pure luck – this is particularly true for the short term. In assessing a gold hedge fund you have to look at what exactly the fund does and whether what it does makes sense. Over the long-term, the luck component drops significantly – looking for strategies that have long-term gains in minds might be a good idea.

Gold Hedge Fund Manager

The hedge fund manager and the investment team are possibly the key element for the fund’s success. It is the final touch of the manager and the analysts that matters when applying various strategies. Because of that, the manager should have considerable knowledge in the area of portfolio management, and also in several other crucial departments, including but not limited to economics and finance. A gold hedge fund manager will also have to have knowledge specific to the precious metals market. This would encompass the knowledge of what possibly drives the prices of precious metals and other market-specific factors.

While the strategy of a hedge fund gives you the general idea what kind of returns and risk you might expect (this is never precise, though), in the end it’s the fund manager who decides on all the details of the strategy and its implementation. Examples of this, specific to gold hedge funds, would include answering questions such as “What kinds of precious metals are owned by the fund?”, “Does the fund own only paper gold and silver or is there a significant share of securities representing real metals?”, “Does the fund invest in senior mining stocks or juniors, or both?”, “Does the fund implement geographical diversification?”, “Does the fund utilize sector-specific rebalancing techniques?” and many more similar questions. It is the manager that answers these questions and comes up with specific trading and investment ideas. As always, much focus is put on the track record of a given manager and investors might choose to gravitate to managers who have outperformed the buy-and-hold approach over a relatively long period of time. Having said that, you have to remember that past performance is not a guarantee of future returns and that trading and investment always involves risk, even with the best of managers.

Gold Hedge Fund Performance

The performance of a gold fund depends on the general performance of the precious metals market (fundamental situation for the precious metals) but also on the fund manager and their strategy. The intuitive measure of how well the fund manages money is its long-term performance. The history of the fund returns and their variability is one of the main considerations here. You have to remember, however, that the past performance of the fund doesn’t guarantee that it will enjoy the same kind of returns in the future as the market might be more unpredictable than one might think.

The typical hedge fund cost structure is called “2 and 20” which means that the fund charges 2% annually on the assets of the fund (annual management fee) and 20% of the profits that the fund generated (performance fee). These costs weigh in on the after-fees performance of the fund. In choosing a gold fund, you have to assess whether the fund adds value in the sense that it’s able to improve the risk-return characteristics of your investment or that it gives you peace of mind which you hold dear. The performance fee seems relatively self-explanatory – it’s the fund’s “reward” for generating profits. The annual management fee is charged to ensure that the fund is able to cover various operating costs such as the costs of setting up a fund, legally required fees, software licenses and various other costs.

Pros and Cons of using a Gold Hedge Fund for one's Gold Investments

The pros of investing via gold hedge funds are tied to the ability of the fund manager to generate profits without making the fund returns too variable and to outperform the classic buy-and-hold approach. It is possible that, with a skillful manager, a gold fund would improve your gold portfolio’s risk-return characteristics, for instance yielding higher returns with less variability, even taking into account fees. Naturally, this may not be the case with all funds.

There is also one more positive side to this kind of funds. Namely, this might be a lot easier than investing or trading yourself since it doesn’t impose on you the need to constantly look at the market and it might help you avoid some of this gut-wrenching feeling when you see your portfolio value decline intraday. It also might help you to not get too emotional about your positions if your portfolio appreciates dramatically. So, a skillful manager might help you get more peace of mind than you would have trading and investing for yourself.

The main con of using gold hedge funds is that it costs. The hedge fund managers’ aim is to generate enough gains so that investing in the fund “pays for itself” meaning that the net effect for investors’ is positive, however there can be no guarantee whether this will be achieved. Also, there usually is a relatively high minimal investment amount, for instance $100,000 which might be a hurdle for individual investors.

Speaking of minimal investment amount, unfortunately investing in hedge funds is not for everyone – one needs to be an accredited investor. This means that one would need to accomplish at least one of the following:

  • Earn an individual income of more than $200k / year, or a joint income of $300k / year, in each of the last 2 years and expect to reasonably maintain the same level of income.
  • Have a net worth exceeding $1 million (excluding the value of the primary residence), either individually or jointly with his / her spouse.

The general partner, fund’s executive officers, directors or a related combination thereof can also invest in a given hedge fund. Regarding institutional investors, a trust or an employee benefit plan can be qualified as accredit investors if their total assets are greater than $5M.

Summary

In the end, the decision whether to use a gold hedge fund or not might depend on whether you’re able to find a skillful gold hedge fund manager. If you find one who can outperform the buy-and-gold approach in terms of both: returns and variability of returns (risk), it might turn out that it’s a good idea to invest in that fund, even including fees. The key here, in our opinion, is finding a good fund manager. To find one, you have to consider their track record (but remember that it doesn’t guarantee future returns), their investment strategy, approach, knowledge and also other personal characteristics. It might turn out that gold hedge funds are a very comfortable way of investing in the precious metals market, given that you find an appropriate manager and that you have significant capital to commit.

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