Hedge Funds in India: Meaning, Types & Investment Strategies

Last Updated on Apr 25, 2025 by vanessa sequeira

Hedge funds are actively managed alternative investments that use non-traditional asset classes or investment strategies. Hedge funds trade in fixed income securities, convertible securities, currencies, exchange-traded futures, over-the-counter derivatives, futures contracts, commodities options, and other non-securities assets in addition to stocks.

What Are Hedge Funds?

Hedge funds are unregistered private investment joint ventures, funds, or pools that invest and trade across a broad variety of markets, techniques, and instruments. They are not subject to the same regulatory requirements as mutual funds, such as providing investors with certain standardised pricing and valuation information regularly. Furthermore, the best hedge funds employ a combination of strategies, like hedging and arbitrage methods, to achieve their investment returns. Being high-value and high-risk investments, hedge funds generally target high net worth individuals and institutions for their clientele.

How Do Hedge Funds Work?

The hedge fund portfolio management is actively done by professionals, aiming to outperform traditional investments by exploiting market inefficiencies. They operate with a relatively flexible mandate compared to other investment vehicles. The same regulatory constraints do not limit them and can invest in a wide variety of assets, including equities, bonds, commodities, currencies, and derivatives. By using sophisticated strategies, hedge fund investments attempt to mitigate risks while capitalising on market opportunities, often focusing on absolute returns rather than benchmarks.

Valuation And Management Of Hedge Funds

A hedge fund invests money from approved investors, including insurance companies, banks, wealthy families, as well as endowments and pension funds. Top-performing hedge funds frequently operate as foreign investment corporations or private investment partnerships. They are not required to register with SEBI (Securities and Exchange Board of India), and they do not need to report their NAV (net asset value) regularly, unlike mutual funds.

Asset types, including derivatives, stocks, bonds, currencies, and convertible securities, comprise a hedge fund’s portfolio. As a result, they are sometimes referred to as alternative investments. They require active management of asset grouping with the aim of hedging risks to investor money against market fluctuations. Unlike other stocks or mutual funds, these funds typically employ significant leverage. They invest in both long and short positions, as well as listed and unlisted derivatives.

Features of Hedge Funds

Hedge funds are structured as private investment partnerships or offshore investment corporations.
Hedge fund trends include a wide range of trading strategies that involve position-taking in various markets.
They may pay performance fees to their managers.
They target wealthy individuals and institutional investors, and have a relatively high minimum investment limit.

Who Should Invest In Hedge Funds?

Hedge funds are similar to mutual funds, but they are managed privately by professionals. As a result, they are usually a little pricier. Because the management buys and sells assets at dizzying speeds to keep up with market changes, you must not only have extra cash but also be an aggressive risk-taker.

As you may be aware, the greater the structural complexity, the higher the hazards. Therefore, the hedge fund industry has a much higher expense ratio than regular mutual funds. First-time depositors may be well-advised to steer clear of these funds unless they have a sizable corpus and a corresponding risk appetite.

Types Of Hedge Funds

Domestic Hedge Funds

Domestic hedge funds are only available to investors who are taxed in the nation of origin.

Offshore hedge funds

Offshore hedge funds are funds that are created outside of your home nation, preferably in a low-tax jurisdiction.

Funds Of Funds

These are mutual funds that invest in other hedge funds beyond geographical borders, a type of mutual fund that pools money and employs two or more sub-managers to invest it in stocks, commodities, or currencies. Investors allocate assets to FoFs for a variety of reasons, including diversity across managers’ styles and risk exposure.

Hedge funds can also be differentiated on the basis of their investing strategy, such as an event-driven fund, which invests in assets to profit from price fluctuations caused by business events. Merger arbitrage funds and distressed asset funds are included in this category.

Global Macro Funds

These are global hedge funds that take long and short positions in major financial markets depending on economic trends and events.

Market-neutral funds

These are those in which the management tries to keep market risk to a minimum (or as low as possible). Long/short equity funds, convertible bond arbitrage funds, and fixed income arbitrage are all included in this category.

Relative Value Hedge Funds

Relative value hedge funds aim to exploit pricing inefficiencies between related securities, such as stocks, bonds, or derivatives. These funds typically employ arbitrage strategies, taking offsetting positions to profit from discrepancies in asset prices. For example, they may buy undervalued securities while short-selling overvalued counterparts, expecting the prices to converge.

Activist Hedge Funds

Activist hedge funds take an active role in the management of companies they invest in, often acquiring significant stakes to influence corporate strategy, governance, or operations. These funds push for changes such as boardroom restructuring, cost-cutting, or divestitures to unlock value. Activist hedge funds aim to enhance shareholder value by driving operational improvements or strategic shifts, typically seeking short to medium-term gains through their influence on the target company.

Hedge Fund Trading Strategies

Hedge fund strategies for growth vary widely, and the approach taken by each fund depends on its specific investment philosophy and goals. Here are some common strategies:

Long/Short Equity: Hedge fund managers take long positions in undervalued stocks and short positions in overvalued stocks. This strategy aims to profit from both rising and falling markets.
Global Macro: This strategy focuses on large-scale economic trends such as interest rates, currency movements, and commodity prices. It involves taking positions based on predictions about global economic events.
Event-Driven: Hedge funds that use this strategy seek to exploit specific events like mergers, acquisitions, or bankruptcies, expecting that these events will drive stock prices in certain directions.
Relative Value: This involves identifying price discrepancies between related securities and taking offsetting positions to profit from the price convergence.
Arbitrage: Hedge funds employ arbitrage strategies by exploiting price differences between two or more markets for the same asset. For example, merger arbitrage takes advantage of the price difference between a target company’s stock price and the offered acquisition price.

Trading Philosophy

A hedge fund is a regulated investment fund that is generally only accessible to a select group of high value investors – high net worth individuals and firms. Every hedge fund has its investment philosophy, which influences the kind of investments made and techniques used. Hedge fund opportunities, in general, engage in a far broader variety of investing and trading activities than typical long-only investment funds (mutual funds, AMCs, etc.). Hedge funds engage in a diverse variety of assets, including long and short stock, bond, commodity, and derivative positions.

Risks And Returns Of Hedge Funds

Apart from the fact that the underlying securities in which top hedge funds invest are similarly high-risk, the product is not legally required to register with the SEBI or to disclose its NAV. These two elements ensure that the rest of the money is closely monitored and regulated. This does not imply that SEBI leaves this money unattended, but the lack of a legal obligation raises the risk threshold. Risk and reward are exactly proportionate, as we all know. Hedge fund returns, like their risks, are on the upper end of the spectrum.

Benefits Of Investing In Hedge Funds

Aligned Manager-Investor Interests: Hedge funds are structured in a manner that aligns the interests of the fund manager and investors, including features such as a high watermark. The high watermark clause permits the fund manager to be rewarded only for their performance if the fund exceeds a particular threshold.
Boosts Market Liquidity: Initially, hedge fund performance can enhance financial market efficiency and increase liquidity. On behalf of their managed hedge funds, many hedge fund advisers take speculative trading positions based on thorough research into a security’s real worth or prospective value.
Corrects Mispriced Securities: Hedge funds utilise short-term trading methods to take advantage of perceived securities mispricing. Because securities markets are dynamic, market prices of securities will shift closer to their real worth as a result of such trade.
Enhances Price Discovery: Hedge fund trading can, therefore, provide pricing information to the securities markets, potentially resulting in more efficient market prices.
Aids Risk Transfer & Lowers Capital Costs: Hedge funds can assist companies in reducing or managing their risks by actively engaging in the secondary market for these instruments, as a portion of the financial risk is transferred to investors through these tradable financial instruments. This market activity has the extra benefit of decreasing the financing costs borne by other sectors by reallocating financial risks. Its exclusion from these markets may result in fewer risk management options and a higher cost of capital.

Taxation on Hedge Funds

Short-Term Capital Gains (STCG)

If you hold equity mutual funds for less than a year, the gains from these investments are classified as short-term capital gains. According to the new budget, these gains are now taxed at a rate of 20%, which has been increased from the previous rate of 15%.

Long-Term Capital Gains (LTCG)

For equity mutual funds held for more than a year, the gains are considered long-term capital gains. The key points to note under the new budget are:

Tax-Free Limit: Gains up to Rs. 1.25 lakh in a financial year remain tax-free. This limit has been increased from the previous threshold of Rs. 1 lakh.
Tax Rate: Any gains above Rs. 1.25 lakh are taxed at a flat rate of 12.5%. It was previously taxed at 10%.
Indexation: It’s important to note that the benefit of indexation, which previously allowed investors to adjust the purchase price of their assets for inflation, has been removed for all asset classes, including equity mutual funds.

Capital Gains Tax	Holding Period	Old Rate	New Rate
Short-Term Capital Gains (STCG)	Less than 12 months	15%	20%
Long-Term Capital Gains (LTCG)	More than 12 months	10%	12.50%

Who Should Explore Hedge Funds

Hedge funds are generally suited for high-net-worth individuals, institutional investors, and accredited investors who have the financial capacity and risk tolerance to handle the inherent volatility. Investors seeking high-return hedge funds should be aware that these funds can involve substantial risk due to the use of leverage and the complexity of the strategies employed. Hedge fund companies cater to investors looking for diversification, especially in alternative investments like commodities, derivatives, and other non-traditional assets.

Factors to Consider Before Investing in Hedge Funds

Before investing in hedge funds, it’s important to consider several factors:

Investment Strategy: Understand the specific hedge fund strategies used by the fund. Different strategies carry different risk-return profiles.
Fees: Long-term hedge fund investments typically charge both a management fee and a performance fee, which can be high compared to traditional investment vehicles. Investors should evaluate whether the potential returns justify these fees.
Liquidity: Hedge fund investments often have lock-up periods, where investors cannot withdraw their capital for a certain period. This lack of liquidity is a critical factor to consider, especially for those seeking flexibility.
Risk Tolerance: Although hedge fund risk management is handled by professionals, investors must assess their own risk appetite. These funds may experience significant volatility, and it’s crucial to have a diversified portfolio.
Track Record: Investigate the hedge fund’s performance history and how it has navigated various market conditions. While past performance is not indicative of future returns, it can offer valuable insights into the fund’s management and risk profile.

To Wrap it Up

Hedge funds are effectively implemented and managed alternative investments that use non-traditional asset classes or investment strategies. In the last 20 years, the number of hedge funds has increased dramatically in India. Hedge funds are more expensive than traditional investment funds, and they often only find interest among high-net-worth individuals or institutional investors.

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Ayushi Mishra

Content Writer at Tickertape

With a wealth of experience as a content writer at Tickertape, Aayushi is passionate about simplifying complex investment modules for the platform's audience. Her writing offers a fresh perspective on the financial world, keeping readers captivated with the latest industry developments. Aayushi's ability to break down financial jargon into easily digestible content sets her apart as a writer who truly understands the needs of her readers.