The investment world has many types of participants, including institutional investors. Each has its own skill set, which it uses to fulfill its investment objectives. In general, venture capital firms invest primarily in high-growth companies at early stages. Hedge fund managers seek to profit by identifying mispriced assets and designing trades to capture their true value.
Professional investors include individual proprietary traders, large insurance companies, and specialized investment firms with specific strategies and objectives. Although each serves a unique function in the economy, both hedge fund managers and venture capital firms manage large investment funds on behalf of investors such as pensions and high-net-worth individuals, and consequently form a very powerful force in the investment world.
In addition to stocks and bonds that can be purchased through a traditional stock brokerage are "alternative investments." These include private equity investments and hedge funds, and are available to certain accredited investors who meet financial sophistication and minimum net worth requirements established by the U.S. Securities and Exchange Commission. Alternative investments provide diversification because their performance is not directly correlated to the that of other more widely available investments. Typically, hedge fund managers seek to align their economic interests with those of their investors, and instead of a commission, are compensated with a percentage of the returns their funds produce.
Hedge funds are private investment funds, which can use a wide variety of complex strategies, including hedging and financial leverage, to enhance their returns. Hedging is a specific risk management strategy designed to offset the potential loss on a particular investment, and it can be done in a variety of ways, including short-selling and the use of option contracts. A hedge fund can focus on stocks (equities), distressed debt (bonds), foreign exchange (currencies), or commodities such as oil, gold or corn, or a combination of two or more of these asset classes. Hedge fund managers can also engage in high-frequency trading, which uses computerized trading models known as algorithms to make trading decisions, or they can rely on their knowledge and expertise to achieve strong investment returns for their investors.
Venture capital firms seek to identify new companies and entrepreneurs that are poised for significant growth. They often focus on technology and Internet-based businesses, and seek to fund a growing company early so it can reach its full potential in a short period of time. Because new companies are often not traded on a stock exchange, venture capital investments are made privately. A venture capital firm's investments are usually tied up for a period of years before it realizes a return and can cash out for its investors.
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