Learn · Hedge Fund Basics
What Does a Hedge Fund Actually Own?
A hedge fund can own Apple. It can bet against Apple. It can bet on the price of oil without ever seeing a barrel, lend money to a company in bankruptcy, trade the Japanese yen, or buy a farm. The freedom is the point: a hedge fund is not a strategy, it is a structure that hands the manager a much larger set of tools.
Most people picture a hedge fund as an aggressive stock fund, the same thing as a mutual fund but run harder. That gets part of it right, but misses what actually makes the structure different. Buying shares is only one of the things a hedge fund can do.
A traditional mutual fund is usually built primarily around a question of what securities to own. A hedge fund can answer that question too, but generally has much more freedom in how it expresses the answer. Whether to bet against something. Whether to insure a position instead of selling it. Whether to leave the stock market altogether and take a view on a currency, a commodity, or a company that has stopped paying its debts.
The familiar part
Most of what a hedge fund owns would surprise nobody. Shares in listed companies, government and corporate bonds — the same instruments sitting inside an ordinary retirement account. Plenty of funds hold little else.
A mutual fund often spreads money across hundreds of positions, partly because most are structured to meet diversification requirements that cap how much can sit in any single holding. A hedge fund can put a quarter of its capital behind a single idea. That concentration can produce outsized results in either direction, which is part of both the appeal and the risk.
Betting against things
Unlike a traditional long-only fund, a hedge fund can also build a position designed to make money when a stock falls. A fund that thinks a company is overvalued borrows its shares from someone who owns them, sells them at today's price, and buys them back later. If the price dropped, the fund keeps the difference.
If it rises, the fund has to buy the shares back for more than it sold them for. That creates a very different risk from simply owning a stock. A share you own can fall to zero and no further, so the worst case is losing what you put in. A share you have sold and not yet replaced can keep climbing, and nothing caps what it eventually costs to buy back.
Betting against things also does something less obvious. A fund holding both directions at once rises and falls less sharply than one holding only the first. That ability to offset one position with another is where the “hedge” in hedge fund originally came from, although many hedge funds today are not primarily designed around hedging market exposure.
Taking a view without owning the asset
A fund can bet on oil going higher without ever owning a barrel. That is what derivatives are for: contracts whose value tracks another asset, allowing the fund to take the exposure without owning it directly.
A futures contract is a commitment to buy or sell something at a set price on a set date. It is how a fund takes a view on oil, wheat, or Japanese interest rates without handling any of them, and it is why a manager who believes Japanese rates are heading up can act on that without ever opening an account in Tokyo.
That works right up until the contract expires. In April 2020, storage tanks at Cushing, Oklahoma filled to capacity, and whoever still held the expiring oil contract was about to receive actual barrels with nowhere to put them. Rather than take delivery, holders paid $37.63 a barrel to hand the contract on. Oil traded below zero for the first time in the contract's 37-year history.
Buying an option can do something a futures position cannot: define the maximum loss before the trade begins. The option costs a fee, and for the buyer that fee is the most that can be lost. A fund holding a stock it likes but worried about the next earnings report can buy the right to sell at today's price, turning an unknown loss into a known cost.
Leaving the stock market
Not every view is about a company. A fund that believes one country's policy will strengthen its currency against another's can hold one and sell the other, which is a position on an entire economy rather than on any business inside it. The foreign-exchange market is the largest financial market in the world by trading volume, and it trades around the clock.
Sometimes the view is simply that a physical thing will cost more later. Oil, natural gas, copper, wheat, gold. Their prices are driven by things that often have little to do with the stock market: weather, wars, supply shortages, and the decisions of major producing countries. That is why a commodity can climb in a month when shares and bonds are both falling.
Leaving public markets entirely
Some funds go a step further and leave public markets entirely.
When a company can no longer pay its debts, its bonds change hands for a fraction of what they promise. A fund buying that debt at forty cents on the dollar is making a specific bet: that once the company is restructured or broken up, creditors recover more than forty. Other funds buy stakes in companies not listed anywhere, negotiating the price directly with the seller rather than taking whatever a screen quotes. Even a company already trading on an exchange will sometimes sell newly issued shares privately, usually at a discount, when it wants capital quickly.
And some funds own things outright. Farmland, timber, warehouses, power generation — assets that earn money by operating rather than by being repriced. A farm collects rent and sells a crop whatever the stock market did that quarter.
Cargill, the agricultural company, ran a fund of exactly this kind for twelve years. Black River Asset Management started in 2003, grew past $7 billion, and bought farmland outright, including in Australia. When Cargill wound the business down in 2015 it was split into three independent firms, and the food and agriculture arm carried on by itself.
None of this can be sold quickly. There is no screen showing today's price and no button that sells, and a farm cannot be liquidated on a Tuesday afternoon. That is why the funds holding this kind of asset are the ones with the longest lock-up periods, a trade covered earlier in this series.
Guess before you tap. Most people get this wrong in the same direction.
Why the range is the whole point
Plenty of hedge funds own nothing but listed shares and would look unremarkable next to a mutual fund's holdings. What differs is the rulebook. A mutual fund sold to the public operates under rules that limit how much of any one holding it may take and constrain how freely it can use leverage and derivatives. A hedge fund works under far fewer of those constraints, which is why the question this article asks has no single answer.
Two funds can both be hedge funds and own almost nothing in common. One holds thirty listed stocks. Another holds currency positions, government bond futures, and a farm. The structure provides the toolkit. What a fund actually owns depends on the strategy.
A note on scope. This article describes the range of instruments available to hedge funds generally. Synora Capital Management, LLC’s own fund, The Wave Fund, L.P., is long-biased and invests primarily in publicly traded equity securities and options on those securities; the instruments it is permitted to hold are set out in its partnership agreement.
All investing involves risk of loss, including loss of principal. Several of the instruments described here can lose more than the amount committed to them, and a wider range of instruments widens the range of outcomes in both directions.
Frequently asked questions
What do hedge funds typically invest in?
Most hold listed shares and bonds, the same instruments found in an ordinary retirement account. Beyond that a fund may sell short, use options and futures, trade currencies and commodities, buy the debt of distressed companies, take stakes in private ones, or own physical assets. What any particular fund holds depends entirely on its strategy.
Do hedge funds use short selling?
Many do, and it is the clearest break from an ordinary fund. The fund borrows a share, sells it, and buys it back later, keeping the difference if the price fell. A short stock position also has no natural ceiling on its loss, because there is no limit to how high the share price can rise.
What are derivatives and why do hedge funds use them?
A derivative is a contract whose value tracks something else, so a fund can take a position on oil, wheat, or interest rates without owning any of them. Funds use them to gain exposure with less upfront capital, cap certain losses in advance, and hedge positions they already hold.
Can a hedge fund own physical things like farmland or property?
Yes. Some funds hold farmland, timber, warehouses, or power generation directly, for assets that earn money from operating rather than from a market repricing them. The trade-off is that none of it can be sold quickly, which is why funds holding this kind of asset tend to have the longest lock-up periods.