Structured Credit Hedge Funds: A Guide for Investors

RediksiaFriday, 5 January 2024 | 07:01 GMT+0000
Structured Credit Hedge Funds: A Guide for Investors
Structured Credit Hedge Funds: A Guide for Investors

DIKSIA.COM - are a type of alternative investment that focus on fixed-income securities and , such as bonds, loans, asset-backed securities, credit default swaps, and options. These funds aim to exploit inefficiencies and mispricings in the credit markets, as well as to hedge against various risks, such as interest rate, default, and liquidity risk. can offer investors diversification, higher returns, and lower volatility than traditional fixed-income investments, but they also entail higher complexity, fees, and risks.

In this article, we will explain what structured credit hedge funds are, how they operate, what are their main strategies, what are their advantages and disadvantages, and how to invest in them.

What are Structured Credit Hedge Funds?

Structured credit hedge funds are a subset of credit hedge funds, which are hedge funds that invest in fixed-income securities and their . Fixed-income securities are debt instruments that pay a fixed or variable interest rate, such as government bonds, corporate bonds, municipal bonds, and bank loans. Derivatives are financial contracts that derive their value from an underlying asset, such as a bond, a stock, or an index. Examples of derivatives include futures, options, swaps, and forwards.

Structured credit hedge funds specialize in a specific type of fixed-income securities and derivatives, known as structured credit. Structured credit refers to securities that are created by pooling and repackaging individual loans or bonds into new securities, known as asset-backed securities (ABS). ABS are then divided into different tranches, or slices, that have different risk and return profiles, depending on the seniority and credit quality of the underlying loans or bonds. Examples of ABS include mortgage-backed securities (MBS), collateralized debt obligations (CDO), collateralized loan obligations (CLO), and commercial mortgage-backed securities (CMBS).

Structured credit hedge funds use various strategies to generate returns from structured credit securities and derivatives, such as arbitrage, relative value, directional, and event-driven. These strategies involve buying and selling different tranches of ABS, as well as using derivatives to hedge or speculate on the movements of interest rates, credit spreads, default rates, and prepayment rates. Structured credit hedge funds also use leverage, or borrowed money, to amplify their returns and risks.

How do Structured Credit Hedge Funds Operate?

Structured credit hedge funds operate similarly to other hedge funds, but with some specific features. Hedge funds are pooled investment vehicles that are open to a limited number of accredited or institutional investors, such as wealthy individuals, pension funds, endowments, and foundations. Hedge funds are not subject to the same regulations and disclosure requirements as mutual funds or exchange-traded funds (ETFs), which gives them more flexibility and secrecy in their investment activities. Hedge funds typically charge a management fee, usually 2% of the assets under management (AUM), and a performance fee, usually 20% of the profits above a certain threshold, known as the hurdle rate or the high-water mark.