A net investment hedge is an aggressive portfolio investment that looks to maximize financial returns through specific moves. In most cases, hedge funds are limited to investors who can make large initial investments into the plan. A hedge fund manager makes aggressive investments in commodities, currencies, and stocks, along with bonds in some markets. The net investment hedge takes offsetting positions in a single security, such as an option and a short sale or a long position and an option. The end result is reduced risk and the potential to have a net gain through each single investment in the overall hedge fund.
Hedge fund investing is not a new practice; in fact, it may be one of the oldest investment forms in the market. While many investors believe these funds reduce or mitigate risk when compared to other investment funds, this is only partly true. Hedge fund managers are often aggressive investors who make a net investment hedge in order to maximize financial returns, sometimes on very risky securities. For example, short selling stocks may not be a common practice for small-money investors. Hedge fund managers, however, look to make successful use of this practice to make money in bear markets.
Using a net investment hedge can sometimes be risky in and of itself. When selling a stock short, for example, an option is necessary in order to be able to sell the stock by a given date. Both of these items require money from investors; in order to be the most profitable, a large amount of capital is often necessary. That is why a hedge fund requires investors who can make large initial capital investments. The risk comes into play because the hedge fund manager is so willing to place large amounts of capital into one stock, which may carry excessive amounts of inherent risk.
Diversification is also essential to a net investment hedge. For example, the hedge fund manager places large amounts of funds into several investments across multiple markets. Stocks, currencies, and commodities are the most popular as these items can have options attached to them. The net investment hedge may then be profitable because gains in the currency portion of the fund outpace losses in stock investments. Or, stock gains outpace the minor gains from commodities and losses in currency trades — either way, the net investment hedge is large enough to provide gains in down markets without creating too much risk for investors.