It is believed that the first futures transactions were carried out with Dutch tulip bulbs in the 17th century. In the mid-1800s it became clear that some systems for standardizing commodity futures would be necessary.
In 1848, the Chicago Board of Trade (CBOT) was founded and has become the most important worldwide futures exchange for agricultural products. For the first time, standardized commodity futures were traded. Variables such as price, quality, quantity and delivery date were standardized.
In late 1970s market participants moved away from traditional commodity futures trading and launch brands such as interest products, currencies and treasury bonds were launched. Nevertheless, the principle of futures contracts stayed the same: a specified price for a specified product was determined for a specified future date.
"Commodity futures trading" simply became"futures trading" but again, the original principle of futures contracts stayed the same.
 What does "hedging" actually mean?
"To hedge" originally meant "to protect against financial loss". Hedging was the idea behind the world's first hedge fund, founded by Alfred W. Jones in 1949. Jones' aim was to create an alternative investment portfolio with successful returns even on investments that showed low or even negative growth when compared with traditional stock and bond markets. Jones wanted to prove that positive returns are possible within both bull and bear markets by using a variety of financial instruments.
Hedge funds are an "all-weather-investment" and are able to achieve profits from rising as well as falling markets. In fact, the less correlation hedge funds have to stocks and bonds, the better. They are considered to be a "market-neutral" investment. The right hedge fund in the right portfolio can minimize risk and optimize performance.
In the world of investing, the hedge fund industry is considered to be the premier option. Only the best fund managers survive, with about half disappearing from the market within the first three years. When choosing a hedge fund manager, a solid track record is important. The fund manager should have a record of at least five years of successful trading.
Hedge funds are NOT highly speculative. This was a myth which derives from a time when hedge funds were an elite vehicle available only to the wealthy and influential. Only investors with $1 million at their disposal were accepted as members of the exclusive club of the hedge fund investment world. The eligibility requirements in combination with the fact that hedge funds are not subject to the same regulatory authority as other investments created a great deal of mystery and speculation about the products and their fallibility.
Today, such rumours are not the reality of the hedge fund world. In many cases hedge funds can reduce risk and volatility in a traditional portfolio. Furthermore, because hedge funds are able to use a significantly greater number of financial instruments they are able to achieve significantly higher gains than traditional investment funds.
In the same way that common sense tells us not to place all our eggs in one basket, CSI does not encourage investors to place all their assets in a hedge fund. Hedge funds should be used as a powerful and effective diversification instrument within a traditional portfolio and in combination with other investments.
In order to reduce the risk and increase returns, an investment of up to 20 % as a part of a traditional investment portfolio is recommended.
The hedge fund philosophy
Hedge funds differ from traditional investment funds in a number of significant ways.
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Hedge funds have a single goal – to achieve gains in rising as well as declining markets |
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Hedge funds have no legal restrictions |
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Hedge fund managers are allowed to make use of all existing financial instruments to achieve gains. |
Today, 8500 hedge funds exist worldwide and manage capital worth more than 1000 billion USD. In comparison, the market capitalization of all US stocks amounts to 16,186 billion USD - about 16 times as much. The hedge fund world is still centered in the USA with George Soros as one of its best-known representatives.
Hedge fund advantages
The overriding goal of a hedge fund is to decrease portfolio risk via non-correlation or negative correlation.
Imagine a portfolio that consists of two risky assets: one wins when the sun shines and the other wins when it rains. Combining both, one has a portfolio that always wins, no matter if the sun shines or if it rains. Now, add a third asset that wins when it is cloudy and, in combination, the portfolio covers all possibilities.
One of the key tenets of Modern Portfolio Theory, as developed by Nobel Prize Laureate Dr. Harry M. Markowitz, is that more efficient portfolios can be created by diversifying among asset categories with low to negative correlations. By diversifying a portfolio, it is possible to reduce risk while also increasing returns.
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